There’s an old joke about a CEO who asks his accountant how much the company earned last quarter. “How much would you have liked?” the accountant replies.
Financial numbers always require some judgment. I’m a fan of GAAP earnings – earnings measured according to generally accepted accounting principles. However, some investment professionals believe cash flow is a more reliable measure.
Cash flow attempts to measure the actual flow of money into and out of a business. It does not take into account interest, taxes, depreciation, and amortization, as these may not be related to current cash inflows or outflows.
When picking stocks, cash flow fans focus on the stock price divided by the company’s cash flow per share. Once a year, I pick a few stocks that seem good in this regard. Here are five that look attractive.
Capital One
Take a bank and put it in a room that looks more like a coffee shop, and you have the basic idea of Capital One Financial Corp. (COF). Its slogan is “What’s in your wallet?” True to that slogan, the company does big business with credit cards.
Over the past decade, Capital One has grown its earnings by 10% annually. Last year was rough, with earnings only growing 1.5%. But I think the next few years will be easier, as the Federal Reserve now seems ready to lower short-term interest rates.
Capital One stock sells for just 2.3 times operating cash flow, a very low ratio. (The lower the better.)
RPC
Unpopular on Wall Street is Atlanta-based RPC Inc. (RES). The company provides oilfield services such as pressure pumping and well control. Earnings have been inconsistent, with six profitable and four unprofitable years in the last decade.
Why would I like such an irregular earner? I think drilling activity will be more intense over the next five years than many people think. And RPC’s balance sheet is a sight to behold: debt is just 3% of equity (the company’s net worth). The stock trades at 6.8 times operating cash flow.
Tutor Perini
Tutor Perini Corp. (TPC), based in Sylmar, California, is an engineering and construction company that builds everything from casinos to bridges to airport terminals.
The company is currently benefiting from increased government spending on infrastructure. After a decade of slowly declining revenues, the company was able to increase its sales by 11% last year. Of the nine analysts who cover the stock, seven like it.
Tutor Perini shares trade at just 2.8 times operating cash flow and just 0.25 times company sales per share.
Cleveland Cliffs
Cleveland-Cliffs Inc. (CLF) generates about two-thirds of its revenue from producing flat-rolled steel and about one-third from mining iron ore. The company’s share price has flattened this year due to the slowdown in the steel industry. Analysts expect the company to report a small loss in 2024.
I think investors have punished this stock a little too harshly. The company is expected to be profitable again in 2025 and 2026. The stock only generates three times operating cash flow at a price of $12 to $13 per share.
International sea routes
International Seaways Inc. (INSW) saw its revenue and profits decline last year. Houthi militias fire on ships passing through the Suez Canal, forcing ships to circumvent Cape Horn instead – a longer and more costly journey.
At the same time, the drought is disrupting operations at the Panama Canal. All of this is inconvenient for International Seaways, which operates 82 ships that transport oil and other cargo. One of my favorite investment techniques is to buy stocks when bad news is real but temporary.
The stock trades at about 4.2 times operating cash flow.
Current account
Since 1999, I’ve written 20 columns on stocks with low price-to-cash-flow ratios. (Today is the 21st.) The average one-year return for my picks in that series was 13.8%, compared with 10.4% for the Standard & Poor’s 500 (including dividends).
Please remember that the results in my column are hypothetical and should not be confused with the results I achieve for clients. Furthermore, past performance is not an indicator of future performance.
My tips were profitable in 14 out of 20 cases, but beat the S&P 500 only half of the time.
Last year, the index beat me badly, rising 28.1% while my stocks rose only 11.5%. Cal—Maine Foods Inc. (CALM) did very well, but I saw only modest gains in BlueLinx Holdings Inc. (BXC) and Peabody Energy Corp. (BTU). I saw losses in Andersons Inc. (ANDE) and Berry Corp. (BRY).
Announcement: I am the owner of Cal-Maine Foods personally and for most of my customers.
John Dorfman is chairman of Dorfman Value Investments LLC in Newton Upper Falls, Massachusetts, and a columnist. His firm or clients may own or trade securities discussed in this column. He can be reached by email.
