| Companies
with Accelerating Free Cash Flow |
Published: June 22, 2004
What is Free Cash Flow (FCF)?
Free cash flow is defined as follows:
FCF = Operating Cash Flow -- Capital Expenditures
To get a better understanding of this formula, we need
to take a closer look at each of its components:
Operating Cash Flow -- This can be found as a line
item on every public company's statement of cash flows. As the name
suggests, it represents the cash a given firm generates from its
day-to-day operations. To come up with this figure, you essentially take
a firm's net income, add back any non-cash charges (such as
depreciation), and then make a few other adjustments (changes in
accounts receivable, inventories, etc).
Capital Expenditures -- This represents the money that
a company uses to purchase or improve upon its physical assets--its
property, plant and equipment.
Why is Cash Flow Important?
Cash flow represents the lifeblood of any growing business. With it,
companies are able to invest in future growth, pay down debt, complete
value-added acquisitions, repurchase stock and pay dividends (if done
properly, all of these tend to be shareholder-friendly activities).
Without a healthy stream of free cash flow, however, most businesses
tend to run into a host of problems. These include ballooning debt
burdens, financing troubles and cash flow management issues, among other
things.
Although most analysts and investors tend to focus
almost exclusively on company balance sheets and income statements, the
reality is that the statement of cash flows gives one of the clearest
pictures of a firm's financial well being. The reason for this is
simple. Whereas net income is often distorted by one-time events,
non-cash charges and a host of accounting tricks, the cash flow
statement gives a clear, unbiased view of exactly how well a company's
core operations are performing.
What To Look For
Because cash flow is so critical to every company's ultimate success or
failure, my staff and I recently went on a hunt for firms that have
shown strong FCF growth in recent years. And while strong growth is
important, we also looked for companies that have posted accelerating
FCF growth. What this means is that these companies are not only
growing, but they're also growing at a faster and faster clip each year.
This type of growth is indicative of firms that are expanding rapidly
and whose products and services are gaining real momentum in the
marketplace.
Companies that are delivering strong FCF growth often
look promising, but keep in mind that stellar growth in and of itself
doesn't make them great investments. After all, a marginally profitable
firm might have little trouble boosting its cash flow from, let's say,
$100K to $200K per year. Although that would amount to cash flow growth
of +100%, for a relatively sizable company, that low level of cash flow
would be virtually meaningless. With this in mind, my staff and I also
looked for companies that are delivering solid cash flow for each dollar
of goods and services that they sell. We did this by looking at each
firm's FCF/Sales ratio. This gave us a list of companies that are not
only growing strongly, but are also highly profitable.
Next, since we're always mindful of valuation levels
before making any investment, we also looked for companies that are
trading at reasonable levels relative to their underlying cash flow. We
did this by examining each firm's Price/FCF per share multiple.
And finally, even though historical growth rates are
important to examine, the reality is that most companies are valued
based on their projected future earnings stream. With this in mind, we
also looked for firms with strong projected future growth (based on
analyst estimates).
With the above analysis as a backdrop, my staff and I
recently searched through our universe of 10,000 stocks to find
companies that met the following criteria:
1. Share price of above $2.00
2. Market capitalization of greater than $100 million
3. Accelerating FCF over the trailing 12-month (TTM) period, as well as
in each of the last three years
4. FCF/Sales of at least 30% (based on TTM data)
5. Price/FCF per share of less than 15
6. Projected long-term growth of at least 15%
Our goal was to come up with a list of reasonably
valued firms with accelerating cash flow growth and healthy cash flow
margins. After running this data through StreetAuthority's advanced
screening software, we came up with the following list of companies (all
prices are as of the close of trading on Monday, June 21st):
| Company
(Symbol) |
Price |
Mkt.
Cap. |
| Advanced Fibre (AFCI) |
$18.82 |
1.6B |
| Asset Acceptance (AACC) |
18.00 |
670M |
| Biovail Corp. (BVF) |
17.26 |
2.7B |
| Clayton Williams (CWEI) |
24.45 |
230M |
| Endo Pharma. (ENDP) |
21.46 |
2.8B |
| Marlin Bus. (MRLN) |
16.17 |
175M |
| Marvel Ent. (MVL) |
18.78 |
2.0B |
| Nassda (NSDA) |
3.86 |
100M |
| PanAmSat (SPOT) |
23.04 |
3.5B |
| Portfolio Rec.
(PRAA) |
25.59 |
390M |
| Ritchie Bros. (RBA) |
26.62 |
900M |
| SS&C Tech.
(SSNC) |
18.87 |
350M |
| Taiwan Semi. (TSM) |
7.25 |
33.5B |
| Votorantim (VCP) |
31.10 |
2.4B |
After having my research staff take a closer
fundamental look at each of the above firms, we came to the conclusion
that all 14 stocks are worth exploring further. As always, however,
please make sure to do your own due diligence on each of these firms to
decide if they are right for your portfolio. Any and all final investing
decisions for your own account are entirely up to you.
|
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