Here is an interesting way to analyze cash flow on a company.
Sorry for the formatting. Go to the link for the real page.
text below from:
text.morningstar.net
by Rika Yoshida and Haywood Kelly
Back in October, we interviewed Brian Posner, the manager of the Warburg Pincus
Growth and Income Fund. In the interview, Posner talked about cash-on-cash
return, a figure he likes to use in his search for undervalued companies.
Essentially, cash-on-cash return is a modified earnings yield. And as with
earnings yield, the higher the cash-on-cash return, the better. However, instead
of expressing a company's earnings per share as a percentage of the stock
price, as the traditional earnings yield does, Posner's version looks at how much
cash flow a company generates as a percentage of how much it would cost an
investor to buy the whole company, including shouldering the company's debt
burden. In other words, if an investor were to buy a company with a
cash-on-cash return of 10%, he or she would be getting an investment that
generated $0.10 in annual free cash flow for every dollar invested.
The Basics
For this Database Detective, we designed a screen around cash-on-cash return.
The first thing we did was to create a proxy for Posner's equation. For the
cash-flow figure, Posner takes a company's EBITDA (earnings before interest,
taxes, depreciation, and amortization) and subtracts out the company's capital
spending. We substituted free cash flow, which is total cash flow less capital
spending. This figure will be similar to Posner's except that it expresses cash
flow net of interest and taxes. In general, that means that our cash-flow figure
will be lower--and thus more conservative--than Posner's.
For the denominator, Posner uses each company's enterprise value, or its
market capitalization plus its net debt. An investor buying the whole company,
lock, stock, and barrel, would not only need to buy all the shares at market
value, but would also be taking on the burden of any debt (net of cash) the
company has. Posner's reasoning is that it's more reasonable to look at the
return a company makes on the entire investment, not just the return it's making
on its market value. Following Posner, we looked for a minimum cash-on-cash
return of 5%.
The Frills
Posner also likes to limit the companies on his shorter list to those which don't
go overboard with their capital spending. That is, they aren't spending so freely
that a glut of new capital investments might radically alter the business' future
cash-generation potential. Companies spending heavily on expansion may be
throwing money into investments that have little or no chance of making a decent
return. That's why Posner generally caps capital spending at 110% of the
companies' depreciation and amortization. The depreciation and amortization on
a company's existing assets is a proxy for the capital spending necessary to
maintain current assets, and by setting a cap slightly higher than that, Posner
opens the door for companies to grow moderately, too.
To narrow the list still further, we added a few criteria of our own. First, we set
a minimum market cap of $300 million, reasoning that very small companies are
more prone to have highly fluctuating cash flows. A tiny company that had very
good recent results is less likely to be able to generate similar results going
forward than is a larger one. We also looked for companies that have increased
their earnings per share in each of the past five years. Increasing earnings are a
proxy for increasing cash flow, and at a minimum, these criteria limit the list of
companies to those that have had stable or growing profits.
Eighteen companies passed all the criteria. They are listed below, ranked by
cash-on-cash return. We've taken a closer look at some of the more promising
investment possibilities.
Company Name and Ticker
Cash on
Cash %
Price/
Earnings
Price/
Cash Flow
Market
Cap ($M)
ASA Holdings ASAI
9.21
16.6
9.4
854.1
Wolverine Tube WLV
9.21
16.1
7.2
435.9
Kimball International B KBALB
8.96
13.3
8.5
765.3
Centex Construction Products CXP
8.41
12.9
11.1
668.3
National Service Industries NSI
7.53
20.3
10.7
2190.6
International Dairy Queen
7.23
15.7
12.8
590.3
Instrumentarium INMRY
7.10
15.2
11.0
665.0
Morton International MII
7.04
15.4
10.0
4576.4
Mueller Industries MLI
6.03
17.0
12.2
1033.0
Helix Technology HELX
6.00
21.1
15.7
385.5
Tracor TTRR
5.39
25.7
9.8
761.2
Federal Signal FSS
5.33
15.4
12.4
986.1
Luxottica Group LUX
5.31
21.1
10.7
2808.1
Quebecor Printing PRW
5.31
15.8
5.3
1717.9
DQE DQE
5.28
14.2
7.2
2728.2
Wallace Computer Service WCS
5.27
20.6
12.8
1670.9
IDEX IEX
5.10
18.5
12.9
1019.8
Mine Safety Appliances MNES
5.07
12.4
8.3
331.3
Data as of 12-31-97. Click on Analysis buttons to read detailed analyses of selected stocks. Click on
ticker symbols to see Quicktake reports for each stock.
P o s t e d : 0 1 - 2 3 - 9 8
Rika Yoshida and Haywood Kelly are editorial analysts for Morningstar
StockIdeas, the electronic newsletter that accompanies Morningstar
StockTools. |
