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Thursday, January 15, 2009

Charts are a mess - using cash flow yield to find strong stocks

Cash Flow Yield - the higher the number, the more cash per share is being generated by the business that is available to shareholders.

That's the definition of the Cash Flow Yield indicator calculated by the Alert HQ software and the TradeRadar software. The indicator is based on a Free Cash Flow determination that starts with Cash Flow from Operations and then subtracts any Capital Expenses. The intention is identify how much cash the company is generating over and above what it takes to pay the bills of the ongoing operations as well to pay for the cap ex investments intended to grow the company in the future. Data from the most recent quarter is used and then annualized so as not to penalize companies that are recovering from bad quarters in the past.

This overall Free Cash Flow number is then divided by the Market Capitalization to generate a percentage which actually equates to cash flow per share divided by the share price.

This is a favored indicator used by many managers (Bruce Berkowitz of the Fairholme Fund, for example) to pick stocks that are generating excess cash rather than burning through cash. In other words, it helps answer the question of whether (excluding from consideration various accounting issues, good will, one time events, etc.) is the basic business profitable?

Getting down to the fundamentals --

At Trade-Radar and Alert HQ, we tend to focus on technical analysis since computers are so good at crunching through price data. With most charts in disarray lately, it seemed a good time to turn to the fundamentals.

It is clear that some very good companies are seeing their stock prices hammered despite the fact that they remain in very strong financial shape. At Alert HQ we are trying to identify those companies by running a screen on cash flow yield. We call the stocks that make the list the Cash Flow Kings.

Besides using this indicator to compare one stock to another, an investor could compare a stock's free cash flow yield to the yield on the 10-year Treasury, for example, to see whether the stock offers sufficient compensation for its additional risk. We set the threshold of our screen way, way above Treasury yields, however, so we think we have a pretty good list of stocks that are worth investigating.

As part of the data we provide we have also included a number of popular value measures such as PE ratio, PEG ratio, price-to-book, price-to-sales and the more common price-to-cash flow ratio. Taken together these indicators provide a good picture of whether the company is profitable, whether its price fully reflects its growth rate and whether it is generating enough cash to run the business. You can sort the data according to your preference and see which stocks rise to the top.

You can download our new list of Cash Flow Kings right here. There are 379 stocks on the list whose cash flow yield is greater than 50%.

Yep, it's free.

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