Value investing is not as simple as it sounds. Last week, I explained the importance of using sophisticated value tools such as relative price-to-earnings (P/E) ratios.
But now, we have to look beyond these common tools if we want to take value investing to the next level…
If you invest this way, you must also look closely at what a company is doing with its money. This means checking things like cash flow from operations (CFO).
This shows how much money a company gets from its core business. It doesn’t count money from extra things like borrowing, issuing stock or selling assets.
CFO is a simple idea to understand on its surface.
Imagine your bank account as a company’s CFO. You get paid, and that money goes into the account. You pay bills from that account. If you get more money than what you spend, that’s good. If you spend more, you might need a loan or have to sell something to cover the difference.
Companies have this issue too. If CFO isn’t enough, they raise money by selling assets or borrowing. This money is called cash flow from other activities, and it’s on a report.
Enron got a lot of its money this way. Earnings grew rapidly. Investors thought it was doing great. But if they looked at Enron’s CFO, they saw problems. Even when Enron said it made a lot of money, the company’s CFO was negative. This was a warning.
Eventually, Enron ran out of accounting tricks and went bankrupt. Investors were wiped out.
There are other examples. But the message is simple: Require a positive CFO in your selection of value investments. Managers may boost earnings and even sales with tricks. But CFO is difficult to fake.
Find a Company’s True Cash Flow
To find out a company’s CFO, start with its profit. Then, add back things like depreciation. This gives an idea of how healthy a company is.
A good CFO means a company can keep going without always borrowing. It shows the company is operating within what it earns.
If a company’s CFO is growing, it’s probably doing well. This can also hint at the company’s potential to reward its investors through higher yields, for example. If there’s not enough CFO, dividends might stop. If CFO can’t cover dividends, it’ll either stop growing payouts or maybe even cut them altogether.
Finding CFO is harder than just looking at a company’s price to earnings. Understanding it is even tougher. Comparing it to other companies can help, although investors should look at more than just this.
I’d suggest comparing CFO growth to other companies. That’s how you can tell the size of the company and how its stock has been doing. Knowing all this can help improve investment choices.
The Power of a Ratings System
Now, all this analyzing and computing can get tricky, but my colleague at Money & Markets, Adam O’Dell, has simplified it for us to an incredible degree.
His proprietary Green Zone Power Ratings system includes a Value rating — as well as a Quality rating, which combines different fundamental criteria such as CFO into a single number. The Value and Quality metrics work together (along with four other factors) to assign stocks an overall rating.
Stocks with “Bullish” ratings are expected to outperform the market by 2X over the next 12 months, and “Strong Bullish” stocks by 3X.
You can find the ratings of more than 4,500 stocks by using the search function on this page. And he’s now used certain factors within this system to develop a brand-new approach to investing.
Adam has finally released his breakthrough Infinitum Momentum Alert strategy based on this powerful ratings system.
Through his research, he’s discovered that by holding the top 10 stocks with strong Momentum, Quality and Value factor ratings and refreshing that list every four weeks, he could outperform the market by 300-to-1 over the long term.
Using this strategy, he’s prepared a fresh list of stocks to buy now so you can start following along.
To learn how you can access this list and see his full research, click here to watch his presentation for Infinite Momentum Alert.
Until next time,
Senior Technical Analyst