We’ve all heard the old trope that “Cash is King.” Well, in terms of a company it just might be. As part of our Green Flag score we have created a line that requires that a company have a positive operating cash flow over the past four quarters.
If you are unfamiliar with what operating cash flow is, it is exactly what the name suggests – cash flow from operations.
Each of our Green Flags must conform to a few rules to ensure that they are actually green flags in investors’ eyes. One such requirement is that a flag must have a win ratio of at least 50%. In regards to this specific flag, you have a win rate of just over 60% – not so bad.
We also want to ensure that the strategy beats the benchmark over the designated time frame – 17 years in this example. Over that time the flag returned 11.89% annually. On the hand the benchmark, S&P 500, returned a paltry 5.18% annually over the same time frame.
Diving a little further into what these returns actually mean – we can go ahead and see if those returns were really worth the risk taken on. We can do this by comparing the Sharpe ratios of the benchmark and our flag and see that our flag has a much higher ratio than the S&P. This suggests that the slightly higher risk taken on throughout the strategy was worth it when compared to simply investing in the S&P 500.
On average, companies that have a positive Operating cash flow tended to continue to have positive operating cash flow for an extended period of time. We held positions for an average of 901 days, and our best position earned us over 8000%. This is not a strategy to invest in as it returns over 1000 companies, but it is a building block for a bigger strategy and an indicator that what you’re looking at investing in is a good buy.