We are experiencing a renaissance. A rebirth.
We were down for the count for a while. Stuck in our homes, we couldn’t go out to eat or to the gym.
It was tough. Today, though, we are emerging. We are reopening.
And while the market has bid up certain groups of stocks already, some still have upside.
I’ll show you…
An Evaluation Tool
Assessing a large group of stocks at one time can be overwhelming.
There are a lot of metrics out there. And sometimes it’s not clear where to start.
One tool I like to use is the “price to free cash flow” ratio (P/FCF). Price is the same as market cap.
The main reason I like this tool is you can’t fake cash.
Free cash flow equals the cash from operations minus capital expenditures. This is the amount a company spends to add to, upgrade or fix important assets.
If a company posts consistent cash flows, then a higher-than-normal P/FCF can mean the stock is expensive. And vice versa.
I ran some numbers to assess this.
I looked at all the companies in the S&P 500 Index with a positive P/FCF. I didn’t include those with free cash flow less than zero.
It shouldn’t surprise you that cruise lines had negative free cash flows last year. So did some utilities and real estate investment trusts. The shutdowns hurt them.
(Some of these names may offer upside as well, but that’s another essay.)
That left me with 424 of the 500 companies in the index.
Next, I looked at the current P/FCF and the average for the past five years.
Finally, I sorted the companies into their sector and sub-industry.
There are 11 sectors in the S&P 500. It includes energy, consumer staples, industrials and tech.
I focused on the sub-industries with at least three names. I included them below if each stock’s current P/FCF was less than its average:
What do these numbers mean? For one, they mean today’s price is lower per dollar of free cash flow than it has been over the past five years.
In general, that’s good if you’re looking for stocks selling at the right price. This can mean different things, though.
For example, names like Dollar General Corp. (NYSE: DG) and Dollar Tree Inc. (Nasdaq: DLTR) may not be as cheap as they appear.
DG saw huge sales growth during the pandemic. Its nearly 22% jump in sales this past year was its biggest annual growth since it went public in 2009. Free cash flow doubled as well.
It may not be able to sustain this pace. So, its lower-than-normal P/FCF here may not mean it’s super cheap.
That said, some of these names look promising here.
As we reopen our economy, people will try to resume their normal lives.
People went to Target Corp. (NYSE: TGT) for essentials last year. Now they’ll return for electronics and fun stuff.
But even if sales don’t grow as much as last year, the price is right at only 12 times free cash flow.
CVS Health Corp. (NYSE: CVS) saw its annual sales increase by $12 billion in 2020. But its market cap fell!
And many of the insurance-related names have struggled. All of the insurance brokers saw their free cash flow grow, but 3 out of 4 of them lagged the market.
Bringing It All Together
Breaking down the sectors using a metric you trust is a solid way to parse the market.
Then, one way to benefit is to play the reopening via a sector or sub-industry.
The SPDR S&P Insurance ETF (NYSE: KIE) includes all four of the insurance brokers in the table. And it’s still trading below its February 2020 highs. It has more room to move higher.
And if you’re looking for individual stocks, check out Ian King’s Automatic Fortunes research service.
Ian is helping people invest in companies that are leading the New American Economy, and he wants you to profit as well.
Click here to learn more about Automatic Fortunes and Ian’s No. 1 stock pick.
Editor, Profit Line