John Dorfman: 5 Stocks That Look Good Based on Cash Flow

If you were invisible, the perfect industrial spy, you could hide in a company’s headquarters and watch every dollar come in and out.

This would give you a great solution on the cash flow of the business. And cash flow, according to many investors, is a great measure of the health of a business.

For stock analysts, a key figure is the “price versus cash flow,” the price of a stock divided by the company’s cash flow per share. Being neither invisible nor omniscient, they must estimate cash flow.

Here’s how it’s typically done: Analysts start with a company’s reported earnings (earnings) per share and make some adjustments. To reported profits, they add depreciation and amortization charges, as these are accounting entries, not necessarily cash expenses.

Then they usually subtract the capital expenditures they deem strictly necessary – replacing aging machinery, rail cars, buildings, etc. The result is called “free cash flow”.

Now they have – or hope to have – an accurate measure of how much money comes in or goes out of the business in any given year.

16.6% yield

Starting in 1999, I wrote 17 columns recommending stocks that look attractive based on price versus cash flow. (It’s the 18th.)

The average one-year return of my choices for this paradigm was 16.6%. This compares to 10.3% for the Standard & Poor’s 500 index over the same periods.

Ten of the 17 columns beat the index and 12 were profitable.

Keep in mind that the results in my column are hypothetical: they do not reflect actual transactions, transaction costs, or taxes. These results should not be confused with the performance of the portfolios I manage for clients. In addition, past performance does not predict future results.

Last year my picks hit an 18.7% return, which I would normally like. However, the S&P 500 jumped 33.5% as the country largely recovered from the covid-induced recession. My top winner, MarineMax Inc. (HZO) climbed 48%. My worst loser, FutureFuel Corp. (FF), fell 29%.

Here are five stocks that look attractive to me now, based on the price-to-cash flow ratio.

A capital letter

You may be familiar with Capital One Financial Corp. (COF) through its TV commercials, which ask, “What’s in your wallet? It is a banking company that tries to give its branches the warm atmosphere of a cafe. The stock is inexpensive in several ways and sells for just over six times free cash flow.

Capital One went public in 1994 and has posted a profit in each of the 27 years since then. Last year he had a bad year; therefore, the stock is cheap. But profits have improved lately.

Argan tree

Argan Inc. (AGX), in Rockville, Maryland, specializes in the design and construction of power plants. The stock has barely moved this year and is a little below where it was five years ago. But if my outlook is good (still a big if), the company should see a big increase in sales and profits soon.

Meanwhile, Argan stocks are languishing at less than five times free cash flow. And the stock provides 2.2% dividends, a decent return. One unusual thing about Argan that I love is that the business is debt free.

MarineMax

I’m bringing back my best winner from last year, MarineMax Inc. (HZO), which describes itself as the world’s largest pleasure craft and yacht retailer. Despite a good gain over the past year, the stock still sells for less than three times free cash flow.

A lot of people don’t like the fact that the rich are getting richer and richer. But if your business sells boats and yachts, that’s not a bad thing.

Synchrony

Synchrony Financial (SYF) issues and administers private label credit cards for Amazon.com, Lowe’s, American Eagle Outfitters, eBay, and dozens of other companies. I think this stock is timely because, as countries recover from the pandemic, credit card usage is likely to increase.

At the same time, credit card defaults, the bane of card companies, are expected to decline. Synchrony shares, which were derived from GE Capital in 2014, trade just over four times cash flow.

Taylor Morrison

Based in Scottsdale, Arizona, Taylor Morrison Home Corp. (TMHC) was the seventh largest home builder in the country by revenue in 2019. I love the whole industry and own a few stocks in it, but not this one.

Nonetheless, Taylor Morrison is one of the cheapest coins in terms of price / cash flow, with a ratio of just over five. It’s cheap by other measures as well, selling for just below book value (company equity per share).

Disclosure: I personally own Synchrony Financial and for almost all of my clients. I own MarineMax for a few clients.

John Dorfman is president of Dorfman Value Investments LLC in Newton Upper Falls, Massachusetts, and a syndicated columnist. His company or clients may own or trade securities mentioned in this column. He can be contacted by email.


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