However, not everyone agrees with this idea. If you are one of those who want to buy stocks even at this point, there is one secret tool that you may use to pick winners: free cash flows.
“Identifying the right stocks for a portfolio is definitely not child’s play in the current situation, but it’s not impossible either if you follow some classic market lessons,” says Vinit Bolinjkar, Head of Research, Ventura Securities. “Conventional market wisdom says you should focus on free cash flows rather than getting carried away by stock price movement, lofty management commentary and revenue and profit growth.”
A free cash flow (FCF) is the excess cash generated by the business that is available to lenders and shareholders. More cash it has, the more it is prepared to expand the business, be ready for contingencies or issue dividends. That means, businesses that are not generating enough cash may be at a disadvantage.
Businesses with high working capital requirements, incurring heavy capital expenditure, those having high levels of debt, companies doing pricey acquisitions and high-growth companies that need to constantly reinvest to keep up pace are some of those that may have low or negative cash flows, say analysts.
So what are the stocks that are generating enough cash to generate our interest? Ventura Securities says only 196 out of BSE 500 companies generated positive FCF to equity (FCFE) yields in the last three years.
FCF to equity yields refer to free cash flows available to equity shareholders divided by their market cap. This does not include newly listed companies and those from the banking and financial space.
The broker says PSU companies have some of the most attractive FCFE yields. IT companies also have robust FCFE yields, irrespective of their market cap classification.
“Some of the biggest blue chips generate negative FCFE yields. A few companies that got battered due to their low ESG (environmental, social and governance) score are now available at lucrative FCFE yields. It remains interesting to see how long investors continue to shun them. Among largecap companies, FMCG and auto companies have stable FCFE yields,” said Bolinjkar.
Analysts caution that free cash flow should not be the only basis of your investment. Check management track record, ESG score, average growth rate of the industry, total addressable market, capex plans and the level of debt on the books, among others, they say.
“Companies with high FCFE which belong to growing sectors, such as IT, may continue to trade at higher multiples, as long as interest rates remain low. Any potential dollar weakness may require close monitoring, though,” Bolinjkar adds.
Perhaps that is why they say revenue is vanity, profit is sanity but cash is the king.
