• Stock Screens
  • Strategic Value Investing: Screening for Cash Flow and Value

    by Robert R. Johnson , Stephen M. Horan and Thomas R. Robinson

    Strategic value investing is about treating each investment as if you were buying the entire business. You need to ask the same questions you would ask if you were starting a business.

    • Is this a business I want to be in and does it have good long-term prospects?
    • Do I expect to get a return from this investment and when?
    • Is the price I am paying attractive given the returns I expect to realize in the future?

    There are many ways of evaluating expected future returns and determining price relative to value, as we discussed in “Selecting a Valuation Method to Determine a Stock’s Worth” (April 2014 AAII Journal). One common method is to evaluate the earnings or cash flow of the business. Now, earnings are nice, but you cannot pay your employees, suppliers, creditors and even yourself with earnings; payment requires cold hard cash. Ultimately to be of value to the owners, a company has to be able to generate positive cash flow. This is true whether you own a small business or are investing in shares of a large publicly traded company. There are other reasons for looking at cash flows, also. Earnings can be easily manipulated by management, and one method of evaluating the quality of a company’s earnings is to look at the relationship between cash flow and earnings. (For more about earnings manipulation, see the book “Asian Financial Analysis: Detecting Financial Irregularities,” by ChinHwee Tan and Thomas Robinson, John Wiley & Sons, 2014.)

    In this article, we present a screen that uses custom cash flow variables designed for Stock Investor Pro (SI Pro), AAII’s fundamental stock screening and research database program, to identify companies with strong cash flow and selling at reasonable prices relative to cash flow.

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    Robert R. Johnson Ph.D., CFA, CAIA, is the president and CEO of The American College of Financial Services in Bryn Mawr, Pennsylvania.
    Stephen M. Horan is a managing director and co-leads educational activities at CFA Institute.
    Thomas R. Robinson , CFA, provides leadership to CFA Institute’s largest region, the Americas, which includes Canada, the U.S., the Caribbean and Latin America.


    Richard Thomas from FL posted over 2 years ago:

    Excellent article, thank you. Please keep more like this coming. It is this kind of fundamental analysis that separates investors from speculators. It is also this kind of publishing that separates investor education from sales hype. Thanks for holding true to your charter at AAII. It is when I read articles like this that I once again consider gifting a lifetime membership of AAII to my children.

    Walter Gardner from TN posted over 2 years ago:

    Agreed, excellent article. I've even successfully input the screen into SI Pro. There was one Custom criterion that I thought was missing in Table 1: CumulativeNI > 0. Otherwise negative values of NI in years 4 and/or 5 would produce unintended outcomes. The advice about doing due diligence is spot on. Some of the companies passing the screen looked to me like real dogs when viewed in light of other measures. Others looked attractive enough for further scrutiny.

    Doug from NY posted over 2 years ago:

    Re: Richard Thomas' comment.

    If the children pay for the lifetime AAII membership themselves, they'll probably be motivated to get more value out of it (at least that's the way it felt for me).

    Perhaps you could buy a year or two for them, to expose them to it. AAII used to be able to reduce the lifetime fee by the current outstanding yearly balance, if one decided to upgrade. I'm not sure if that still holds, though.

    Manjunath Sharma from CA posted over 2 years ago:

    Performance of the screen (cash flow value) using some backtest (Factset, Capital IQ) is needed to see if this works. Value stocks can remain as "value stocks" for a long time.

    Thomas Robinson from FL posted over 2 years ago:

    Walter - good observation on restricting cumulative net income to be greater than zero. I indeed used to have that in the screens but then realized that screening for companies with positive cumulative CFO and for a CumulativeCFIndex greater than one already rules out cumulative negative earnings (otherwise CumulativeCFIndex would be negative). Including the culumalative net income screen greater than 0 would not hurt though.

    Ghassan Ziab from NJ posted over 2 years ago:

    Great article indeed. I backtested the method but only starting in February 2013. I didn't include companies that passed the screen in January. The results were incredible but the holding period was short. Sometimes only one month. I need to compare it to a benchmark fro the same period.

    Manjunath Sharma from CA posted over 2 years ago:

    FCFAvg3 = ([FCFY1]+{FCFY2]+[FCFY3])/3
    It appears, for this particular variable has a syntax error and SI Pro would not create it. Replace { with [ and it worked. Just letting others know. Results of this screen as of 6/6/2014 is as follows.

    Manjunath Sharma from CA posted over 2 years ago:

    Anyone who wants to network in Orange county (Irvine CA) please let me know

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