To find stocks to add to our portfolio, we often times screen for stocks with financial stability, good free cash flow, and attractive valuations. Once we reduce the choices to a manageable number of stocks, we then perform additional qualitative analysis to determine if the company is attractive enough to invest in.
For the following list, we used the following three metrics to reduce the number of stocks in our investment universe to a short list of candidates. We further reduced the number of stocks to those that had an analyst rating of 3 (Hold) or above. We then handpicked a few that looked interesting based on our preliminary analysis. We recommend you perform further analysis to determine if any of them are a good fit for your portfolio.
Free Cash Flow/Sales % - this metric indicates to us that the company does a good job of creating adequate cash flow relative to the level of sales they currently have. Since the measure is relative, we can compare companies of different sizes to determine their investment potential relative to a wider universe of otherwise non-similar companies. Free cash flow is defined as Net Operating Income adjusted for taxes, minus changes in net working capital, minus capital expenditures, plus depreciation. The higher the free cash flow of a company the better, but since smaller companies cannot generate the same amount of cash as larger companies, we use the FCF/Sales % metric to compensate.
Current Ratio - this metric consists of Current Assets divided by Current Liabilities. It basically indicates a company's ability to pay their short-term liabilities with current liquid assets. A further analysis would be justified to determine if a large portion of current assets consists of inventory and how liquid the inventory is. Otherwise, current assets consist of cash and short-term investments which we assume are very liquid.
Price to Cash Flow less than the 3 year average P/CF - this measure is our first indication of whether a company may be undervalued relative to it's long-term average. There could be other factors at play which we look into in further detail. But basically, a P/CF that is less than the 3 year average of that stocks P/CF can be an indication that there could be multiple expansion in the future and or cash flow is expected to decline. Obviously, we are looking for stocks that fit under the former scenario … price multiple expansion.
1. Cisco Systems Inc (NASDAQ:CSCO)
Cisco Systems, Inc. designs, manufactures and sells Internet protocol (IP)-based networking and other products related to the communications and information technology (IT) industry and provide services associated with these products and their use. The company provides a line of products for transporting data, voice, and video within buildings. Its products are designed to transform how people connect, communicate, and collaborate. Its products are installed at enterprise businesses, public institutions, telecommunications companies, commercial businesses and personal residences. It has five segments: United States and Canada, European Markets, Emerging Markets, Asia Pacific and Japan. In November 2011, it acquired BNI Video. In March 2012, the company acquired Lightwire, Inc. In May 2012, the company acquired ClearAccess. In July 2012, it acquired NDS Group Ltd. For additional information, check out "Buy Cisco: Dividend Growth, Market Leadership And Cheap Valuations."
2. Allergan Inc. (NYSE:AGN)
Allergan, Inc. is a multi-specialty health care company focused on developing and commercializing pharmaceuticals, biologics, medical devices and over-the-counter products. The company operates in two segments: specialty pharmaceuticals and medical devices. The company discovers, develops and commercializes a diverse range of products for the ophthalmic, neurological, medical aesthetics, medical dermatology, breast aesthetics, obesity intervention, urological and other specialty markets in more than 100 countries. In May 2011, a generic version of Elestat was launched in the United States. On June 17, 2011, it acquired Alacer Biomedical, Inc. (Alacer). On August 8, 2011, it acquired Precision Light, Inc. (Precision Light). On July 22, 2011, it acquired Vicept Therapeutics, Inc. (Vicept). During the year ended December, 31, 2011, it discontinued its EasyBand Remote Adjustable Gastric Band System. In February 2011, it discontinued the United States sales of Zymar. For their earnings transcript, check out "Allergan Management Discusses Q2 2012 Results - Earnings Call Transcript."
3. Google Inc (NASDAQ:GOOG)
Google Inc. (Google) is a global technology company focused on improving the ways people connect with information. The company generates revenue primarily by delivering online advertising. As of December 31, 2011, the company's business was focused on areas, such as search, advertising, operating systems and platforms, and enterprise. Businesses use its AdWords program to promote their products and services with targeted advertising. In addition, the third parties that comprise the Google Network use its AdSense program to deliver relevant advertisements that generate revenue. In June 2011, the company launched Google+, a way to share online. As of January 2012, over 90 million people had joined Google+. In April 2011, the company acquired PushLife. In September 2011, the company acquired Zagat. In May 2012, Google acquired Motorola Mobility Holdings, Inc. (NYSE:MMI). On July 31, 2012, it acquired marketing start-up Wildfire. For a more detailed article, check out "Google's Valuation Remains Attractive."
For possible risks, read "Google Is Going To Be A Big Loser."
4. Oracle Corporation (NASDAQ:ORCL)
Oracle Corporation, incorporated in 1977, is an enterprise software company. The company develops, manufactures, markets, distributes and services database and middleware software, applications software and hardware systems, consisting primarily of computer server and storage products. It operates in three segments: software, hardware systems and services. Its software business is consisted of two operating segments: new software licenses and software license updates and product support. Its hardware systems business consists of two operating segments: hardware systems products and hardware systems support. Its services business is consisted of three operating segments: consulting, Cloud Services and education. On January 5, 2011, Oracle completed the acquisition of Art Technology Group, Inc. (ATG). On August 11, 2010, the company completed the acquisition of Phase Forward Incorporated (Phase Forward), a provider of applications for life sciences companies and healthcare providers. For more information, read "Why Oracle Is Significantly Undervalued."
5. Priceline.com Inc. (NASDAQ:PCLN)
priceline.com Incorporated is an online travel company that offers its customers hotel room reservations at over 210,000 hotels worldwide through the Booking.com, Priceline.com and Agoda brands. In the United States, the company also offers its customers reservations for car rentals, airline tickets, vacation packages, destination services and cruises through the priceline.com brand. It offers car rental reservations worldwide through rentalcars.com. In the United States, the company also offers customers the ability to purchase other travel services, including airline tickets, rental car days, vacations packages, destination services and cruises through both a traditional, price-disclosed retail manner, and through its demand-collection system known as Name Your Own Price. During the year ended December 31, 2011, it re-branded TravelJigsaw as rentalcars.com through rentalcars.com, it offers retail price-disclosed rental car reservations worldwide. For more info, read "Priceline Now A Great Buy."
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.