While earnings are still the primary metric used to judge company performance and measure the attractiveness of a company’s stock price, a growing wave of investors focus on cash. Cash levels help reveal the financial strength and resources of a company, while cash flow indicates the generation of new cash. Cash flow can reveal whether the company is generating or consuming cash in its normal operation, if it is investing for the future, and whether it is rewarding investors with dividends or seeking additional capital from the equity or debt markets. Cash flow analysis often provides advance notice that a company may be facing financial trouble even though earnings and sales are still looking strong.
We have examined a number of cash and cash flow calculations in the stock screens area of AAII.com (www.aaii.com/stkscrns/archive). “Screening for Cash Rich Firms” seeks out companies with high levels of net cash on hand relative to the company’s market value. The principle underlying this screen is that the cash can be the ultimate safety net for a firm. With a large cash hoard, a firm should be able to weather an economic storm, undertake expansion, or fund productivity improvements for future growth.
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