Intro and 2016 Results
First and foremost I would like to wish a Merry Christmas & Happy New Year for the viewers who read my articles on Seeking Alpha. Within the first few weeks of 2016, I released an article with the companies I believed would beat the Dow Jones Index. The main valuation metric used was price to free cash flow and quality being cash return on invested capital. Below I will show the performance for this year.
|Apple Inc (NYSE: AAPL)||$1,000||$1,191.20||19.12%|
|American Express (NYSE: AXP)||$1,000||$1,381.30||38.13%|
|Boeing (NYSE: BA)||$1,000||$1,274.50||27.45%|
|Caterpillar (NYSE: CAT)||$1,000||$1,639.70||63.97%|
|Cisco (NYSE: CSCO)||$1,000||$1,321.50||32.15%|
|IBM (NYSE: IBM)||$1,000||$1,411,70||41.17%|
|Pfizer (NYSE: PFE)||$1,000||$1,099.10||9.91%|
|UnitedHealth (NYSE: UNH)||$1,000|| |
|Stock Picks Listed Above||$8,000||$10,774.50||34.68%|
|SPDR DJIA ETF (NYSE: DIA)||$8,000||$10,100||26.25%|
If you had selected the 8 companies listed in the article with the same equal weighting, you would have outperformed the Dow Jones Index ETF by 8.43%!
Below is an explanation of the metrics used for the research and what figures are needed in order to qualify for further due diligence. Banks and Insurance companies are unreliable due to large fluctuations in the annual reports, and these companies are highlighted in yellow. You would be better served by looking at the book value per share, return on equity and return on assets figures for clarity on financial performance. All information taken is from the last reported annual report or trailing twelve months for those who haven't released their Q4 earnings yet, the figures were taken from Morningstar.com.
CapFlow: To get this figure we simply dividend the annual capital expenditure by the cash flow from operations. This gives investors an idea of the percentage used to maintain the business from its cash flow. Any cash left over is what we call the free cash flow, which can be used for acquisitions, dividend, share buybacks or reinvested into the business. To score a point on the screen we'll look for no more than 33% of cash flow being spent on capital expenditure.
CROIC: Cash flow return on invested capital is used by dividing your free cash flow by the long term debt & total equity. This simply tells you the return the business earns on the money it invested. For example a company above 20% CROIC means it makes more than 20 cents for each $1 invested.
FCF Yield: This is basically the inverse calculation of the P/FCF metric, investors use this to assess the valuation of a stock. It's widely known to be better than P/E as this uses free cash flow, which is harder to manipulate compared to the earnings. To score a point on the screen we'll look for 7% or more, which is the inverse of P/FCF 15 (100 / 15 = 6.66)
My Picks For 2017
Looking at the information provided in my spreadsheet, my picks for 2017 to outperform the Dow Jones Index are Wal-Mart Stores (NYSE: WMT), International Business Machines, Apple, Cisco and Boeing. Interestingly 4 of the picks are the same, with Wal-Mart being the only addition. American Express, Caterpillar, Pfizer and UnitedHealth have been dropped. My special pick for 2017 ignoring the metrics above will be Disney (NYSE: DIS).
Wal-Mart Stores is the cheapest company in the Dow index based on a price to free cash flow of 10.24. It also has a 4 star risk rating on Morningstar, representing that the stock could be undervalued, or that the possible returns outweigh the risks.
Even though the company reported a small decline in revenue and net profit, capital expenditure has also been declining, giving the company just under $16 billion in free cash flow. With dividends only costing $6.3 billion, the company has $9.7 billion it can use on buyback programs or possible acquisitions and investments. The company increased the dividend by 2% this year.
International Business Machines has remained a conviction play for Warren Buffett as many investors have been skeptical of the company's future. The 2016 annual report hasn't been filed yet but TTM figures show that revenue has remained flat while net income may have declined by 11%.
With $15 billion in free cash flow, dividends cost $5.2 billion leaving the company with $9.8 billion it can use on buyback programs or possible acquisitions and investments. The company increased the dividend by 7.7% this year.
Apple is fast becoming a services company, which has grown by 20% consecutively for many years now, relieving the pressure to sell the latest iPhone. The ecosystem and infrastructure that Apple has, which includes the App store and Apple music, which already have 20 million subscribers in 18 months, is a recurring revenue stream for the business.
Even though revenue declined by 7% this shouldn't deter investors. The company has the largest cash hoard in the world estimated at over $230 billion! Large enough to purchase any company apart from the top 13 by market cap. With $53 billion in free cash flow, dividends cost just over $12 billion leaving the company with $41 billion it can use on buyback programs or possible acquisitions and investments. The company increased the dividend by 9.6% this year.
Not much can be said for this giant networking products and services company within the telecommunications / information technology sector. Revenues remain flat but net income increased by 19.5% which is incredible. With $12.4 billion in free cash flow, dividends cost just over $4.7 billion, leaving the company with $7.7 billion it can use on buyback programs or possible acquisitions and investments. The company increased the dividend by 24% this year.
Boeing is the USA's largest exporter of manufactured goods by value, and with headlines concerning Trump's Air Force One jet and fears over job cuts, negativity keeps hitting the company regardless of its performance.
Closely matching the Dow index this year, I think the company has room to run in share price. Boeing has the best cash return on invested capital, beating Apple due to a reduction in margins. With TTM data showing $8.1 billion in free cash flow, dividends cost just over $2.7 billion, leaving $5.4 billion it can use on buyback programs or possible acquisitions and investments. The company increased the dividend by 30.3% this year.
I have done a separate article on Disney this year. It has under-performed the Dow index, reporting an 8.16% total return in that period vs. 14.47%. I consider the company significantly undervalued. I plan to follow this up with a future article with updates to its theme park business, its media business along with its minority stake in BAMTech and how the consumer business more than makes up for the negativity surrounding its ESPN subscriber losses. I would like to point out that the movie line-up for 2017 is incredible to say the least!
Disney's revenue still grew by 6% looking at the annual report in September, and net income rose by 12%, hardly the decline that talking heads would lead you to believe. With $8.4 billion in free cash flow, dividends cost just over $3 billion, leaving the company with $5.4 billion it can use on buyback programs or possible acquisitions and investments. The company increased the dividend by 10% this year.
I believe these 6 companies will outperform the Dow Jones Index and it is interesting to notice that with the data I've provided, the market isn't massively overpriced. Though it is indeed harder to find bargains, you just need to put in the work to find them!
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Disclosure: I/we 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.