Bank of America: free cash flow is an important indicator of a sound company of value

Bank of America: free cash flow — an important indicator of a reliable company of value

The bank advises investors to pay attention to three characteristics in a period of high volatility.

What to look out for

Since the beginning of 2022, investors have been shifting from expensive growth stocks to value stocks. All because, that the market fears an increase in interest rates FED. In such a situation, it is important to distinguish cost from cost traps.. That is, fairly valued companies - from simply cheap.

According to Bank of America, a reliable value company has such signs:

  1. Inflation Protection. The company must have "price power" - the ability to raise prices and pass their costs on to the buyer.
  2. recession resistance. The company must earn even during periods of recession in the economy, when consumers cut spending.
  3. Stable free cash flow. This is cash flow from core operating activities less capital expenditures..

The first two are clear.. Why is the third important?.

Benefits of Stable Streams

Free cash flow is a key parameter in the reporting of any company. For at least three reasons, experts say.

Reliable dividends. Regular dividends are an important component during a market downturn. And stable cash flow helps companies pay dividends and buy back shares on their own., not borrowed money.

Fair Multipliers. Investors often value companies by multiples.. Most Popular: P / E - capitalization to profit and P / B - capitalization to book value.

Investment company Cambiar Investors believes, that these multipliers have flaws. So, accounting profit includes various non-operating and non-recurring items. For example, sale of shares in other companies. And book value may incorrectly account for intangible assets, such as brand and patents. Cash flow has no such disadvantages.

There are multiple cash flow based multipliers. One of them is FCF. / P, or free cash flow yield. According to the Prudent Speculator, at a distance this indicator works better, than P / E or P / B.

Clear forecasts. Investors don't like uncertainty. And so companies with stable flows become more attractive., especially in difficult times", - says the consulting company Gamco Investors.

  The oldest share in the world

But companies with negative cash flows sell first, when the whole market goes down. These are usually companies, who promote new technologies and "sell" investors a dream. A good example is Cathy Wood funds like ARK Innovation..

What about income

In December 2016, Pacer ETFs provider launched the US Cash Cows fund.. It includes the shares of the so-called money cows.. This is one hundred companies from the index Russell 1000 with a high free cash flow yield. For example, this is Pfizer, Bristol-Myers и Intel.

Until recently, the fund lagged slightly behind S&P 500, as value stocks have lagged behind growth stocks in recent years. Now the situation has changed. Over five years, the dividend fund yielded 114%, and the return S&P 500 — 102%.

You can read more about cash flows and other parameters in the fourth lesson of the free course "How to make money on stocks".

Bank of America: free cash flow — an important indicator of a reliable company of value

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