Investors should often remind themselves that businesses derive their values from the cash flows they generate over time. When markets are climbing higher, that fundamental lesson is often forgotten, because rising stock prices tend to cloud sound business judgment. Many interpret a rising share price with excellent stock picking skill, quick to forget that a rising tide lifts all boats. Now is not the time to forget.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Improving Fundamentals
To be sure, the U.S. economy continues to demonstrate improving fundamentals. Housing seems to be on the mend and the unemployment picture is brightening up. Add in a dose of low interest rates and it's easy to see the tailwind being applied to equity prices. However, investors would be wise to exercise caution with each rising market day.

While Amazon's (Nasdaq:AMZN) dominance as the world's largest online retailer is clearly the way of the future, the company's current enterprise value of $75 billion values the business at 44 times EV/EBITDA. While Amazon's future is certainly exciting, shareholders may come to realize a different experience. On the other hand, big boring Wal-Mart (NYSE:WMT), the world's largest traditional retailer, is changing hands at 7.4 times EV/EBITDA. On top of that, the shares yield 2.6%, nothing to sneeze at today. Indeed over the past 12 months, Wal-Mart shares are up about 17% versus a 10% return for Amazon.

Cash (Flow) is King
Companies producing attractive cash flows today are in a better position to insulate themselves from economic uncertainties. Many of these companies are taking a backseat to more exciting names, like Apple (Nasdaq: APPL); Xerox (NYSE:XRX) is a prime example. Trading at about $8.40 a share the company has a market cap of $11.3 billion. With $8.6 billion in debt, the company has an EV of $19 billion. Yet, over the past three years, the company has generated an average of nearly $2 billion in free cash flow each year. That cash flow is real, not a promise of growth.

DirecTV (Nasdaq:DTV) is also a high quality business pouring out cash flow. DTV trades for an EV/EBITDA ratio of less than 7 and is generating $2 billion to $3 billion a year in free cash flow. The company is experiencing rapid growth in areas outside the U.S., where cable penetration is low and demand is strong. Folks still keep the cable running during tough times.

The Bottom Line
Solid cash flow producing companies tend to have solid performing share prices over the course of time. Investors often get caught up with the allure of exciting gains, failing to realize that excitement is the enemy of the value seeking investor. Exciting gains can come with terrific losses; yet, the truly successful investment results come to the businesses with steady production of cash flow.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Starbucks: Profiting One Cup at a Time (SBUX)

    Starbucks is everywhere. But is it a worthwhile business? Ask the shareholders who've made it one of the world's most successful companies.
  2. Stock Analysis

    How Medtronic Makes Money (MDT)

    Here's the story of an American medical device firm that covers almost every segment in medicine and recently moved to Ireland to pay less in taxes.
  3. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  4. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  5. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  6. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  7. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  8. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  9. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  10. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center