Consistent Cash Creators, Part 3: The Value Screen

Continuing my series on Consistent Cash Creators, this week I’ve pulled all my previous work together to create an actual screen. In Part 1 of Consistent Cash Creators, I examined the most consistent cash generating companies. I received some excellent feedback. In response to a comment regarding the appropriateness of using a linear trend model, I examined whether it is better to use a linear or exponential trend for free cash flows in second part of this series. Today, I’m going to respond to the other comment I received regarding the sorting of the list by value and including several key fundamental price ratios.

I first started out by using a database of about 9,000 companies. I then filtered out companies in the financial sector. From that list I kept only companies with average returns on invested capital greater than 10% over the past five years. I used this metric as a proxy for sustainable growth. Finally, I filtered out companies that did not exhibit positive free cash flow growth per share over the past seven years because this is suppose to be a list of cash creators, not destroyers. Applying these filters resulted in a list of 974 companies.

The next step involved determining how consistent these remaining companies grew their free cash flows. I took the linear regression of free cash flows over the past seven year and determined how close free cash flows followed a linear trend using the r-squared statistic. I then only kept companies that had r-square values greater than 0.70. This reduced the remaining list of companies to 169.

This list of consistent cash creators includes many great companies. However, many of these companies are richly valued. In order to find the best values, I decided to use Joel Greenblatt’s Magic Formula earning yield (EY) metric to sort the list of consistent cash generating companies. This EY is equal to a company’s operating earnings before interest and taxes divided by its enterprise value. The following table lists the top 30 companies sorted by earnings yield:

Consistent Cash Creators

The top stock on the above list, NutriSystem (NTRI), sticks out in my mind, because it is one of Geoff Gannon’s picks for the SINLetter stock contest. There are also many oil industry stocks in the results. But with oil at all time highs, I’m not sure that these stocks provide a margin of safety. Some of you might also notice several stocks on this list that are popular with fellow value investors, including: American Eagle Outfitters (AEO), Moody’s (MCO), and Sherwin-Williams (SHW).

I’m pleased with the results of this screen. However, I don’t recommend blindly investing in any of these companies. I think each one must be further examined to determine if their business has a sustainable competitive advantage. In addition, each company should be valued to confirm whether the price of these stocks provides for a significant margin of safety. If you find this list helpful, please let me know. I could publish it here periodically if there is interest.