Five Stocks That Look Alluring Based on Cash Flow
Posted: August 15, 2017
Suppose you are the CEO of a successful corporation. Your gleaming headquarters building is an ornament to your city.
The building was paid for with cash, back in 2007 when business was booming. Yet each year, when you calculate your company’s profits, you subtract $100,000 a year for depreciation on the building.
In this pleasant hypothetical case, the cash flowing through your company is $100,000 more than its reported annual profit. This is one of many ways in which a company’s cash flow can differ from its reported earnings.
One common definition of cash flow is earnings before interest, taxes, depreciation and amortization, or EBITDA.
Does EBITDA give a truer picture of a company’s health than the GAAP (generally accepted accounting principles) earnings figure?
I think both figures capture part of the truth. If I could only use one, I’d pick GAAP earnings. However, once a year in this column, I highlight companies selling for a low price compared to cash flow.
That series (now entering its 14th year) has done well. My cash-flow selections have achieved an average 12-month return of 22.8%. By contrast, the Standard & Poor’s 500 Index has averaged 8.2% a year over the same 13 periods.
Ten of my 13 columns on the subject have been profitable, and ten (not exactly the same ten) have beaten the S&P 500. The articles appeared in August 1999-2006, and August 2012 to the present.
Bear in mind that my column recommendations are theoretical and don’t reflect actual trades, trading costs or taxes. Their results shouldn’t be confused with the performance of portfolios I manage for clients. And past performance doesn’t predict future results.
Last year’s picks were profitable but feebly so, gaining 3.45%. The S&P 500 for the same period (August 23, 2016 through August 11, 2017) posted a 13.87% total return.
Delta Air Lines Inc. (DAL) did well, as did Lear Corp. (LEA). But I had losses on Dillard’s Inc. (DDS), Atwood Oceanics Inc. (ATW) and Net 1 UEPS Technologies Inc. (UEPS)
Now, it’s time for some new picks.
I’ll lead off with Prudential Financial Inc. (PRU) of Newark, New Jersey, which sells life insurance, mutual funds and other financial products. At its current price of around $106, Prudential sells for less than eight times cash flow.
Life insurers collect premiums and pay out death claims – but often many years elapse in between. Meanwhile, the insurers can invest some of the money, typically in bonds. If interest rates rise in the next few years – as I think likely – they will be getting fatter coupons on those bonds.
A small insurance company I like is United Fire Group Inc. (UFCS), out of Cedar Rapids, Iowa. United Fire is debt free, a quality that often attracts me. It has been increasing its dividend, and the dividend yield stands at 2.6%.
Hardly anyone on Wall Street follows United Fire, and the few who do follow it don’t recommend it. Yet the stock seems attractively cheap at five times cash flow and 1.1 times book value (corporate net worth per share).
Even more neglected by Wall Street is Weyco Group Inc. (WEYS), a Milwaukee, Wisconsin company that imports and sells shoes under the brands Stacey Adams, Nunn Bush, and Florsheim. Weyco’s revenue and earnings have declined in the past couple of years. Yet it has some strong points.
Weyco has very little debt. It offers a 3.2% dividend yield. Its stock sells for seven times cash flow, or eight times free cash flow. (Free cash flow takes into account capital expenditures a company needs to make.)
Argan Inc., based in Rockville, Maryland, makes electrical generating plants. Most are fueled by natural gas, some by alternative fuels such as biodiesel, ethanol, wind or solar.
Argan shares go for less than four times cash flow, and about 13 times reported earnings. The company’s chairman and vice chairman, Rainer Bosselmann and William Griffin Jr., own a nice chunk of the stock, something I like to see. And the company is debt free.
MDC Holdings Inc. (MDC) is a Denver-based homebuilder. Colorado is its stronghold but it also builds homes in California, Maryland, Virginia and other states.
Investors fear homebuilding stocks, I believe, because of the great homebuilding bust of 2007-2011 and also because they fret that rising interest rates will make home ownership less affordable. On the latter score, I think the worry is premature and overdone. The stock goes for less than seven times cash flow.
Disclosure: I own Argan shares for a few of my clients.