Screening For the Most Consistent Cash Flow Generators in a Richly Valued Market

Not many bargains at today's prices but consistent cash flow generators to watch for buying opportunities.

My recent post on the valuation of the current market noted that the overall market is richly valued relative to the cash flow generated by companies.   When the market is priced richly, I prefer to be stricter in my criteria for screening for companies in which I might make a new investment.  So, in this month’s screen for the most consistent free cash flow generators, I extend the window of time for which I look for consistent and growing cash flows.  Historically I have used a five-year period.  In this screen I will look back over 10 years for overall growth and consistency while retaining 5 years for some ratios where recent data is more relevant.

I have run a screen on Russell 3000 companies with strong and consistent free cash flow generation. I look for companies that generate a Free Cash Flow to the Firm (FCFF) Return on Assets of at least 5% a year over most of the last decade, have increasing cash flows and for which a time series regression of free cash flow over time shows more consistent growth in cash flows.  I include other important screening factors, some using 5 years of data or trailing twelve months, as well such as:

Ability to Generate Cash Flows

• Five years of positive cumulative free cash flow to the firm and net income

• High free cash flow to the firm relative to total assets over the past ten years

• Increasing free cash flow to the firm over the last ten years (also relates to growth)

• Stable or increasing free cash flow to the firm relative to total assets over the past 10 years.

• Operating cash flow over the last five years higher than earnings over the last five years

Valuation/Growth

• For this screen, I prefer to focus on high cash flow generators and do not place a restriction on FCFF yield (Free Cash Flow to the Firm/Enterprise Value) other than to require that it is not negative. The screen is designed to pick up both value and growth opportunities.

• Similarly, I do not set a minimum growth estimate but do require that growth is positive.

• I limit the results of the screens to those where the potential total return in terms of both FCF Yield and growth is at least 10% in total. 

Quality

• Inclusion in the Russell 3000 but avoiding very low-priced stocks.

• High Piotroski F Score

• High Altman Z Score

• Reasonable debt levels

• Consistency in generating free cash flow to the firm over the last ten years.

• Operating cash flow over the last five years higher than earnings over the last five years

• Reasonable levels of non-cash stock compensation relative to enterprise value

This screen results in 69 Russell 3000 companies that are the strongest, consistent FCFF generators.  This list of stocks is worthy of additional analysis and a formal valuation to consider as an investment opportunity.  Data presented is as of January 31, 2024. 

Overall, this list has an average FCFF Yield of 4.1% equivalent to an EV/FCFF multiple of 24.4 times.  This is slightly higher than the Russell 1000 which currently has a EV/FCFF multiple of 22 times.  So, this group is overall priced a bit more richly than the market but generate more consistent cash flow.   Additionally, analysts’ consensus growth forecasts average 13.7% so these companies are priced a bit more richly due to their expected growth.   Overall, these companies generate enough FCFF in a five-year period to replace 73% of their total assets (or to be used to distribute to capital providers or grow the firm).  Looking at analysts’ price targets shows that these companies are on average selling within 3.5% of their price targets.  Again, richly priced, and certainly not bargains overall.  There are 10 companies that have at least 10% upside to their target price.   

It is notable that the list includes 5 of the Magnificent 7 stocks – Apple, Alphabet, Microsoft, Meta and NVIDIA.  Also note Meta’s price has run up already with its recent earnings and dividend announcement in the last couple of days.

The list does not include bargains, but these are high quality stocks that are worth watching and doing further analysis when buying opportunities occur.  Note that I currently own a number of the stocks on these screens in my portfolio and the remainder are on my personal watch list.

Full subscribers can download an excel file with the data below: