Focusing on Cash-Flow Stocks

by: Davy Bui

When you see cash flow, you've got to buy it.

I read that statement in an interview with a money manager in Barron's last week and it stuck with me. So this sentiment provides the theme behind this week's stock screen, which emphasizes free cash flow (FCF). Here were the specific criteria I used for the screen on the Morningstar site:

  • Free Cash Flow as % of Market Cap >= 25;
  • PEG Ratio <= 1;
  • Return on Equity ttm % >= 15

View the full list of results here.

A couple of comments about this screen: We are looking for cash flow, yes, but sustainable cash flow is the key, not a company in decline. Thus, the requirement for a PEG ratio under one, which could signify either fast expected growth or a cheap stock with some expected growth. Notice the first and third requirements may leave some exposure to debt-heavy companies. FCF as a % of market capitalization excludes the company's debt load.

Hence, a company could theoretically have high cash flow relative to its market cap but low cash flow relative to its enterprise value, which includes debt. This same dynamic also influences the ROE, which could be abnormally high if a company has a debt-heavy capital structure.

With that caveat out of the way, the results of the screen yielded interesting results. Two China stocks, China Biologic Products (NASDAQ:CBPO) and China Mass Media (NYSE:CMM), made their way onto the list but after my experience with China 3C Group (OTC:CHCG-OLD), I am very wary of small-cap Chinese stocks, especially if they are not listed on an exchange.

The rest of the screen spans a wide range of industries from payday lender Advance America, Cash Advance (NYSE:AEA) to WESCO International (WSS), an industrial company and not the financial company associated with Charlie Munger. Innophos Holdings (NASDAQ:IPHS) makes a repeat appearance from a previous screen a few months back.

Readers can view the full list in spreadsheet form here.

Disclosure: none