- Investment strategies
- Why invest in the stock market?
- Buy and hold or technical analysis? Why you need an investment plan
- Value investing and short selling in volatile markets
- Using technical analysis to support value investing
- Investing in the unexpected
- Franking credits, explained
- What is dividend stripping and is it a sensible strategy?
- Investing in quality IPOs
- How to invest in stocks that benefit from a moving Australian dollar
- Reasons to avoid bonds when interest rates are low
- How value investors use Skaffold
- Quality, growth and value = a winning strategy
- Know your investor type and boost your performance
- Technical + fundamental analysis = better buy and sell decisions
- Fundamental investing
- Value investing and the price earnings ratio
- Intrinsic valuation models and methodology
- Value investments or value traps?
- How to find value stocks in a bull market
- Find value investments in expanding markets
- Why capital raisings struggle to add investment value
- How to value an insurance company
- Top stocks
- 5 qualities of top stocks
- How to find stocks with a competitive advantage
- Why return on equity is the best measure of business performance
- Using cash flow to find value investments
- Finding high quality dividend stocks
- Debt is not always a dirty word
- Why Skaffold share investment software makes sense
- Using economic factors to uncover the best investment options
- How do experts find top stocks to invest in?
- Investing in global stocks
- How to invest in international shares on global stock markets
- Benefits of investing in international shares
Using cash flow to find value investments
The best stocks to invest in are those that produce an ongoing funding surplus. Use cash flow to find them.
There’s no better insight into what’s left for you as a shareholder in a business, once it’s paid all its bills, than an analysis of cash flow. When it comes to assessing the investment quality of a company's cash flow, you should be attracted to those with sufficient money in the bank to fund their operations and produce an ongoing Funding Surplus.
While every business operates to generate cash, you should exercise caution around stocks that often show a Funding Gap. This occurs when there’s insufficient cash to continue operating and the company is forced to take on debt or raise capital from shareholders.
Funding surplus or funding gap?
A Funding Surplus or Gap can be arrived at by subtracting the capital expenditure, investments and dividends paid from the company's Cash Flow Generated from Operations.
The greater a company’s Funding Surplus the more likely it is to avoid excessive borrowing, expand its business, pay dividends and withstand any economic downturns.
The trouble is that deciphering whether a company is self-funded (generating more money than it spends) or relies on external funding – after factoring in its operations, investments and financing – isn’t always a straightforward exercise. That’s why Skaffold’s automated software has simplified the process for you by charting up to ten years of data from a company's Profit and Loss and Cash Flow Statement.
Skaffold’s Cash Flow for every company is updated annually, following the release of the company’s annual report. Skaffold uses a (colour-coded) Cash Flow Evaluate screen to interpret the complexities of a company’s history of reported net profit after taxes (NPAT), cash flow generated from operations and dividends paid. What you’re left with is a clear understanding of how the cash generated by a business has been utilised and whether or not the company has required external funding to finance its activities.
Let’s look at exactly how Skaffold’s Cash Flow Evaluate screen works, and then draw on a live example to show you how easy it is to use. The Cash Flow Evaluate screen is designed to give you a historical snapshot of a company’s overall cash flow position using two key indicators. The blue line reveals the cash flow generated from operations, the green line indicates the Funding Surplus or Gap.
CSL Limited (CSL)
CSL Limited (CSL) is a great example of a company that has consistently strong cash flow generated from operations relative to reported net profit after taxes.
Skaffold presents CSL’s cash flow statement
You should be attracted to companies with blue and green lines that are trending upwards, like CSL’s, as they have consistently generated rising profits and improving Cash Flow Generated from Operations.
Breville Group (BRG)
As another example, here’s what Skaffold data tells us about appliance maker Breville (BRG’s) cash position.
Skaffold presents Breville’s cash flow statement
Between 2003 and 2012, Breville has invested $98.233 million, paid dividends of $107.706 million and paid out other financing cash flows and foreign exchange effects of $5.752 million, resulting in a Funding Surplus (green line) of $90.797 million.
BRG’s cash flow has been in surplus since 2008, and based on its 2012 full year results the company’s Funding Surplus is just over $20 million – giving it an attractive Cash Flow Ratio of 1.10.
BRG’s Funding Surplus indicates the company does not currently rely on external sources of capital to fund its business activities. Based on the strength of its low debt, healthy bank account, future ROE projections above 20 per cent, and healthy cash flow surplus, BRG is awarded an attractive Skaffold Score of A2.
GUD Holdings (GUD)
With a Skaffold rating of A2, BRG’s direct competitor, GUD Holdings (GUD), manager of Sunbeam appliances, is also a very attractive stock. But when you compare GUD’s Cash Flow Ratio of 0.66, it’s easy to see which one you’d rather own.
Not all big companies have good cash flow
You need to be wary of well-known large-caps with unhealthy cash positions which may still attract uninformed investors due to their size. High profile stocks with a history of large debt and poor cash flow – which contribute to poor Skaffold Scores – include: Seven Group Holdings (SVW), James Hardie Industries (JHX), Oil Search (OSH), Leighton Holdings (LEI), Asciano (AIO), Duet Group (DUE), Tabcorp Holdings (TAH), Transurban (TCL), Brambles (BXB), Origin Energy (ORG), SP AusNet (SPN), APA Group (APA) and Sydney Airport Holdings (SYD).
Don’t overlook cash flow
A company’s cash flow is a crucial ingredient in producing sufficient money in the bank to fund operations, pay dividends and produce a funding surplus. Look for those companies that have something left over for you as a shareholder, after they have paid their bills. They are the ones that will produce lasting and growing value in your portfolio.