Now, this flag looks incredibly simple, but whenever you see orange text in Equities Lab, it means that there is a deeper formula to explore. Clicking on that formula we are presented with the following –
Though the flag itself is simple, the underlying formula is not. Understanding and analyzing cash flow statements takes time. Thankfully, we can do it easily here by importing the Cash Flow Score – a number from 0 to 10 based on the above metrics. For each line that is true for a company, it will score 1 point. The lines look for the following –
- A company must be ranked in the bottom 35% of all companies within their sector for (total debt 1Q/free cash flow t12m) and free cash flow MUST be a positive number.
- Yearly Operating Cash Flow is greater than it was two years ago
- Quarterly Operating Cash Flow must be higher than five quarters ago.
- A company must be ranked in the top 45% for their Trailing 12 month Cash Delta divided by the average diluted shares.
- Quarterly Operating Cash flow as of two quarters ago, must be higher than operating cash flow six quarters ago.
- A company must be ranked in the top 45% across their sector for their Free Cash Flow Per Share (FCF/Average Diluted Shares)
- Cash EPS one quarter must be higher than Cash EPS five quarters ago
- Trailing Twelve Month Free Cash Flow(FCF) must have increased by 15% over the past year
- A company must be ranked in the top 45% of all companies within their sector for their trailing twelve month Cash EPS
- Quarterly debt must have dropped by 10% over the past six months OR Diluted Shares outstanding must have dropped by at least 3% over the past year.
No score passes our test if it seems biased to one sector or market cap. In looking at the High Cash Flow Score flag, we can see that the companies found(150 or so at any point in time) have a wide array of characteristics, and the score doesn’t seem to pigeonhole itself. It appears that the closest it comes to that is finding that companies that have a high EPS – and when has that ever been a bad thing?
As per one of our rules when it comes to green flags, the strategy must beat the benchmarked S&P 500 over a given period. Much like the rest of our flags, we set that time frame to 17 years. Of course, the strategy beat the benchmark, but the screen capture that you see below is what surprised me.
The correlation between companies found using the High Cash Flow Score and the S&P 500 is staggering. The regression line is almost straight, and there are very few points in quadrants 2 and 4. So, if the strategy and the S&P 500 have a high correlation, how did the strategy return so much more than the benchmark? Simple, the flag just has higher weekly returns.
Finally, we need to ensure that the strategy has an over 50% win rate. We do this in each of our flags because it is a significant component of assigning the “Green flag status” to a field. It doesn’t matter if you made 1000% more than the market, if your strategy relies entirely on the gains of a few companies to offset your losses, your screen will never hold up in the real world.
Remember, flags like this aren’t investing strategies on their own; instead, they are pieces of a larger puzzle, and bits of information that will guide you to making a better-informed investment decision.