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Managing Editor’s Note: Today, we’re hearing from our contributing editor Mike Burnick in his weekly feature.
Mike has over 30 years in the investment and financial services industry – from operating as a stockbroker, trader, and research analyst, to running a mutual fund as a registered investment advisor and portfolio manager, to being Research Director for the Sovereign Society, specializing in global ETF and options investing.
And he’s been senior analyst at TradeSmith for three years, running Constant Cash Flow, Infinite Income Loop, and Inside TradeSmith.
Here’s Mike…
Here’s How to Find Stocks Offering Double-Digit Cash Flow Yields
BY MIKE BURNICK, CONTRIBUTING EDITOR, MARKET MINUTE
Earnings season is just about done with over 450 of the S&P 500 reporting already.
A key reveal this earnings season was a lack of enthusiasm for positive earnings surprises, due mainly to over-inflated profits.
What’s more telling, stocks that fell short of sales estimates got hammered. Even when they beat earnings forecasts, stocks dropped 3% the day after reporting.
Investors are paying more attention to the quality of earnings, and that quality is deteriorating. Stocks with positive free-cash-flow growth are rewarded, while those with declining cash flow get punished, even when they beat earnings estimates.
Free cash flow (FCF) is simply a company’s operating cash flow, minus capital expenses. And it’s the best way to find quality stocks that aren’t inflating earnings.
Case in point, two Magnificent 7 stocks, Google parent Alphabet (GOOGL) and Amazon (AMZN), both reported low-quality earnings and got whacked.
Two-thirds of Alphabet’s net income was due to “paper gains” on investments in Anthropic and SpaceX. Plus, its free cash flow went negative for the first time ever!
Amazon also booked big paper gains of $53 billion last quarter, and posted negative free cash flow for the last two quarters.
Take FCF per share and divide by a company’s enterprise value (stock market cap + debt) and you’ve got the free cash flow yield.
Just like a stock’s dividend yield, a higher FCF yield indicates a quality stock that may be undervalued relative to the cash it generates.
The average stock in the S&P 500 has a FCF yield of just 2.5% today.
But by using our TradeSmith Screener, I found 80 nonfinancial stocks in the S&P 500 with FCF yields above 5%, or twice the S&P 500 average – 21 with double-digit yields!
Subscribers can use our Screener tool to quickly find them. Simply log into TradeSmith Finance, and from the main menu bar, click Invest and then Screener in the sub-menu.
Next, start a new screener by clicking on + Add Filter, then insert a few simple filters, as shown above.
The filters are:
- Markets > add S&P 500 Index
- Dividends, Cash Flow & Ownership > add Free Cash Flow Yield, set at more than 5%
This screener will find stocks in the S&P 500 with a FCF yield at least twice the S&P 500 average.
When I ran my screen with these filters, I got 80 results, many of them healthcare, industrial, and energy stocks.
The top 10 shown below are sorted by the FCF Yield column, with the highest at the top.
Bottom line: Cash is king when earnings are inflated by paper gains. Free cash flow is the best single measure of a stock’s quality in my book. And you can use our popular TradeSmith Screener to find stocks with strong free cash flow and the potential to beat the market.
Good investing,
Mike Burnick
Contributing Editor, Market Minute