A transparent market place with computerized screening devices available to virtually every retail investor has arguably reduced the amount of ‘undiscovered’ stocks. Still, there only so many investor dollars to go around in publicly listed stocks. Some prefer deep value companies with low price-to-book ratios while others will lean toward smaller cap high-growth stocks. Even though a stock might be ‘discovered’, it does not mean that the majority of investors will show a preference to it with their investment dollars.
Take, for example, the most popular numbers when quarterly reports come out:
current and forecast earnings
current and forecast revenue
Although there are many other useful numbers such as net profit margin, asset turnover, and financial leverage, most investors focus on the most popular numbers, thereby limiting their preferred stock picks to companies that excel with these ratios. We will look beyond revenue and earnings and focus on cash - which many view as king, as does Warren Buffett.
Scanning for Growing Cash Cows
The goal of our scan here is to pick up stocks based on changing free cash flows. Here is what we will look for:
Cash flows increasing every quarter for the past three quarters
Cash flows for last year more than the year before
Free Cash Flow 1-year growth to exceed FCF 3-year growth
EPS growth greater than industry average
FCF growth greater than EPS growth on both 1 and 3-year time frames
Price-to-FCF to FCF-growth less than 1.2 (Similar concept to PEG but based on FCF instead)
No over-the-counter exchanges
There are a few reasons why I like this screen. I like that the cash flow is growing between quarters and years. The growth rate of the FCF is accelerating. I throw in an EPS growth rate bigger than industry average, but I require that FCF growth exceed EPS growth. I do not want pitiful cash growth hiding behind a big EPS number. Finally, I do a quick valuation check using price to free cash flow and the amount of FCF growth. (You might also like 7 Free Cash Flow, Dividend Kings)
Rising FCF Kings
Only 3 stocks make this rigorous examination.
Polaris is expected to grow at an average 15% annually over the next 5 years, which is slightly above industry averages. Growing up in a small community situated in the valley between snow-capped mountains helped me become familiar with their snowmobiles. The free cash flow per share has continued to jump over the past few years.
2008 - $1.48 FCF / share
2009 - $3.00 FCF / share
2010 - $5.49 FCF / share
With a payout ratio of only 37%, I fully expect them to begin to raise this over time. This stock has been a great performer since September of 2010, and I anticipate a pop above the $80 resistance if the April 18th earnings announcement is good. From there it could trek further up the stock market slopes.
Neutral Tandem, Inc.
Neutral Tandem assists competitive telecommunication companies to interconnect into a network.
The company may look fairly valued when comparing PE, P/B, and P/S. However, it clocks in on the lower end with a price to FCF of 14.6 versus an industry average of 17.3. The growth rate of the FCF per share is very exciting with 5-year averages at 36%, 3-year averages at 116%, and 1-year FCF growth at 190%. Some of the margins such as ROA, ROE, and Net Profit Margins have dipped when looking at 2009, but the multi-year trend is up.
MICROS Systems, Inc
The final FCF growing stock is MICROS Systems, Inc. This company provides information solutions to the hospitality and retail industries. Having worked as a waiter in a restaurant 17 years ago, I appreciate how they are integrating the Internet with ordering terminals.
This stock looks to be on the upper limit of fair valuation when comparing it to PE, PEG, P/S, P/B, and other common ratios. Even on the Price to FCF it is only a fraction below the industry average. However, the cash flow per share and FCF per share growth has greatly exceeded the industry, even though EPS growth is below. Net profit margins, ROA, ROE, and the current ratio are all popping – which is good.
Total sales per share might be far from what is used to be, but if the cash flow per share continues to climb quarter over quarter as it has been, this could be a FCF cow to hang onto. (You might also like to read about 12 Small Cap High Yielding Dividend Stocks Under $10)
If you have other cash flow, or FCF stocks that you love, please leave a comment and let other readers know about it.