John Reese, founder of GuruInvestor, wrote an article back in January focusing on free cash flow yield, a favorite investment criteria of Bruce Berkowitz, manager of the five-star Fairholme Fund. Berkowitz believes a stock should have a FCF yield greater than 10% for his fund's consideration. Reese put together a list of stocks with yields between 14 and 30%. I thought it would be interesting to see how some of these stocks performed in 2009. To make sure we're comparing apples-to-apples, I'll use stocks that have a strong brand name, a market cap between $1 billion and $10 billion and aren't part of either the financial services or utilities sectors.
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Five Highest FCF Yields - Stocks Greater Than $10 Billion
|Company||Market Cap||FCF Yield - Jan. 11, 2009||YTD Return||Current TTM FCF Yield|
|Dish Network (Nasdaq:DISH)||$4.36B||25.06%||89.00%||28.44%|
|Lexmark International (NYSE:LXK)||$1.98B||19.92%||(5.72%)||(3.35%)|
Interpreting The Data
One of the great things about the internet is the amount of information that's available. However, it becomes a Catch-22 anytime you're using information from one site that itself has taken data from various other sites to aggregate and then present in some logical format. The errors that can occur are significant, especially when you are using data from the trailing 12-months and not a fiscal year-end. Investors should always analyze results from multiple sources to ensure they are accurate and make sense. Taking for granted that the information is correct just because you've found it at a popular investment site is a recipe for disaster. It's always important to check and recheck.
A Few Question Marks
Several thoughts enter my head as I read the results. Taken as gospel, it appears that AutoNation's cash flow yield has dropped as its stock price has risen. That's normal. Dish Network had a great year in the markets and appears capable of rising even further in the coming months while Macy's looks to have some more gas in the tank despite a weak retail environment. The two that really jump out at me are IAC/Interactive and Lexmark. If my calculations are accurate, both businesses have seen a significant impairment in their cash flow and explanations must be at hand. I'll dig into their financials to see what I can uncover.
A Logical Explanation
IAC/Interactive's decline in FCF yield is due to two significant expenses in the fourth quarter of 2008. The first was a $234.7 million write-down of its investment in German retailer Arcandor AG and the second was a $63.2 million loss on the extinguishment of $734.2 million in its senior notes. Once we hit the end of December, those numbers fall off the cash flow statement resulting in a free cash flow yield considerably higher than above. I'm not sure it will hit 20% but it definitely will be healthy. As for Lexmark, its printer business is seriously leaking ink with declining earnings in each of the last four years. As of Q3 2009, the company's net earnings were $86.2 million compared to $222.1 million a year earlier. A fifth year of declines is in the cards and free cash flow could be under $200 million for the first time since 2001. It's certainly understandable why the stock is down year-to-date.
None of these stocks is in the Fairholme Fund. That's primarily because Berkowitz invests in large cap stocks. However, the examples herein help demonstrate the importance of free cash flow and the corresponding yield produced by this cash generation. If a five-star fund manager thinks it's an important valuation metric, investors should too. (To learn more about free cash flow, check out Free Cash Flow Yield: The Best Fundamental Indicator.)
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