Cash flow stock picks aim for 10th win in row
Businesses live or die by cash flow.
Cash flow measures the cash an enterprise generates. Because it excludes such non-cash items as depreciation and amortization, cash flow may be stronger than reported earnings, or weaker.
From time to time, usually each August, I recommend a few companies that look attractive based on the ratio of their stock price to the company's cash flow per share. Last year, I recommended Archer-Daniels-Midland Co. (ADM), KKR & Co. (KKR), MetLife Inc. (MET), Phillips 66 (PSX) and Western Digital Corp. (WDC).
Western Digital, which I own for almost all of my clients, returned 57 percent to lead the field. Phillips 66 (50 percent) Archer-Daniels (38 percent) and KKR (24 percent) all beat the Standard & Poor's 500 Index. Only MetLife trailed, at 12 percent.
All figures are total returns including dividends, from August 20, 2013, through August 15, 2014.
Overall, last year's list posted a 36.5 percent return, compared with 20.8 percent for the S&P 500.
Bear in mind that results for my column recommendations are hypothetical and don't reflect trading costs or taxes. Past performance doesn't predict future results. And the performance of my column picks shouldn't be confused with results I obtain for clients.
This column is the 11th in my series on cash flow. The previous ones were published each August in 1999-2006 and 2012-13.
On average, my selections, based on low price to cash flow, have returned 29.4 percent per year, compared with 7.9 percent for the S&P 500 over the same 10 one-year periods.
My selections lost money and trailed the S&P in their first year, 1999-2000, but since then have beaten the S&P nine consecutive times. Eight of the ten sets of recommendations have been profitable.
Again, the same caveats apply.
I no longer recommend Archer-Daniels, but my other four picks from a year ago still appeal to me. Here are some fresh selections. Each of these sells for less than eight times cash flow.
In addition, each sells for less than 10 times free cash flow. Free cash flow is cash flow minus a company's actual expenditures for capital equipment and dividends.
I'll start the festivities this year by recommending Hewlett-Packard Co. (HPQ), which has been a stock-market dog for the past four years. Computer printers are a cut-throat business, the high profit margins on cartridges are starting to come down and the executive suite has been a revolving door.
Despite all that, I like the stock, which I see as having upside surprise potential. At 11 times earnings and seven times cash flow, I think it is attractive.
Everest re Group Ltd. (RE), with headquarters in Hamilton, Bermuda, and a stock traded on the New York Stock Exchange, appeals to me because of its rising revenues and improving earnings. The company is a reinsurer — in essence, an insurer's insurer.
In years without too many hurricanes, reinsurance is a highly profitable business. Last year, for example, Everest had a 21 percent profit margin. The stock trades at six times free cash flow.
St. Joe Co. (JOE) owns about 185,000 acres of Florida real estate. It used to own more than a million acres but has sold most of it, including most of its timberland last year. The company develops some properties itself and works with developers on others, which may be residential, commercial or resort properties.
Cash-flow negative for many years, St. Joe has positive cash flow and sells for about six times free cash flow.
Barnes & Noble
The bookstore chain Barnes & Noble Inc. (BKS) runs more than 1,300 bookstores — 661 retail bookstores and 700 college bookstores. It sells conventional books on the Internet and electronic books through its NOOK unit.
At six times free cash flow and 0.2 times revenue, the stock looks intriguing, although it is expensive if you value it on reported earnings. One strength that is sometimes overlooked: The company has about $340 million in cash and cash equivalents.
If you dare buy a Japanese company, I think Sony Corp.'s American Depositary Receipt (symbol SNE) is worth consideration. Once a world leader in product design for consumer electronics (a role that has passed to Apple Inc.), Sony is still a behemoth with $75 billion in annual sales.
The company has struggled in recent years, but cash flow is improving, and the out-of-favor stock sells for only three times cash flow and six times free cash flow.
Although I own none of these stocks for clients, I believe they are all worthy of consideration. We'll see if we can extend this series' winning streak to 10 years.
John Dorfman is chairman of Thunderstorm Capital LLC in Boston. He can be reached at firstname.lastname@example.org.