Rules of the Game: Further on Free Cash Flow

 | Dec 06, 2012 | 12:30 PM EST  | Comments
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Earlier this week, I began a mini-series on free cash flow per share as a gauge of a firm's ability to finance projects and operations without additional debt.

To recap, here's the formula for free cash flow: a company's cash from operations, minus capital expenditures. For cash flow per share, divide by the number of shares outstanding.

The other day, I wrote about Visa (V), which has seen its free cash flow per share increase in each of the past four years.

While there are various sectors represented on my scan of top large-cap cash cows, I couldn't help noticing how many medical stocks showed up.

Looking at the price action first, there are reasons why medicals are among investor favorites these days. Through technological advances, people are living longer but requiring more medical care as they age. And these technological developments often result in some hot, in-demand products.

For example, Intuitive Surgical (ISRG) has been increasing sales of its robotic surgery systems at rates of 18% or more in each quarter in the past two years. Earnings decelerated over the past two quarters, coming in at $3.54 per share, a year-over-year increase of 16%.

Free cash flow per share has grown in each of the past three years, coming in at $14.81 per share most recently.

Intuitive Surgical's chart shows a stock that is holding up better than most in the benchmark index, but it has been consolidating since early May. The stock shed 2% on Wednesday, closing at $516.77, below both its 50- and 200-day averages.

For now, any potential buyers should wait for a rebound above the 200-day line. The fundamentals bode well for this company --  analysts are eyeing earnings gains of 21% and 19% in the next two years.

Another medical name that made my top cash-flow scan is Novo Nordisk (NVO), the Danish maker of diabetes treatments.

The stock rallied to an all-time high of $170.27 in October, and it has been consolidating since then. It got support right at its 200-day line, a good signal of technical strength.

Novo Nordisk's free cash flow per share increased in each of the past four years and was at $5.48 per share most recently.

The earnings growth story remains intact: Wall Street expects per-share income of $6.53 this year, up 18% from 2011. Next year, earnings are seen growing another 20%, to $7.81 per share.

A big-cap growth name that I have tracked for months is Alexion Pharmaceuticals (ALXN). The company specializes in treatments for neurological disorders, transplant rejections and other hard-to-treat ailments.

After emerging from the bear market in March 2009, the stock had a fairly steady upward trek to an all-time high of $119.54 on Oct. 4. It has been basing since then, trading below its 200-day average for the past two months.

Technically, this stock has some more work to do before it regains any kind of leadership status. I don't like to make a purchase when a stock is south of its 200-day, so this remains a watch-list name for the moment.

The cash flow per share grew in each of the past three years and was $1.30 most recently. The earnings picture also bodes well. Analysts are eyeing income of $2.05 per share this year, a gain of 49%. Perhaps even more important for a stock that's undergoing a lengthy correction, earnings are seen growing 35%, to $2.77 per share next year.

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