Using Cash Flow Instead of Earnings to Figure Price Targets

It isn't enough to decide you like a stock simply because of a company's products or services. Every stock has a 52-week high and low. Those levels are often far, far apart even thoughwhat the company does didn't change. Here are the Aug. 21 closing quotes for seven diverse companies along with their trailing 12-month peaks and nadirs through Aug. 20. Those who bought the lows are already very profitable. For those who paid top dollar, though, the same shares, with the exception of Apple , don't look as good. I use Value Line data every day to help evaluate data. The service has been around since before I was born. An old-time feature, the Value Line, is incorporated into each price chart, yet most present-day investors are not even aware of it or know how to use it. The Value Line analyst on each stock covered picks a multiple of cash flow per share for the company in question. That constant ratio, expressed below in the Legend box, is shown as 13.0x cash flow per share for Apple, which is a holding of Jim Cramer's Action Alerts PLUS charitable trust. Ratios for other firms in different industries will vary, but the multiplier will always remain constant through the approximately 15 years of stock price movement shown. Cash Flow is defined below. It equals reported earnings plus any non-cash charges that decrease earnings per share (EPS) for tax purposes but don't actually require paying money out of pocket. The data shown on AAPL has that solid line running through the already-reported numbers followed by a dashed line indicating future cash flow expectations based on estimates. The data boxes in this article show each stock's price to cash flow ratios at key best buying opportunities and should have sold moments. As with price-to-earnings (P/E) rations, price-to-cash flow (P/CF) ratios can vary widely depending on general market conditions as well as company-specific factors. It usually pays to buy only when those ratios are cheaper than normal for the stock in question. I've done the math to illustrate this on a few stocks -- Apple, Thor Industries , The Children's Place and Alliance Data Systems -- and left another few charts unannotated so that you can try this exercise yourselves. The beauty of the Value Line -- a.k.a. the cash flow line -- is the ease of seeing whether a stock looks cheap or expensive. Simply see how the shares look in relation to their typical orientation to that solid line. Just before Apple's split back in 2012 it sold for 14.7x cash flow. Half a year later the stock was down from over $100 to $55, where it fetched just 7.5x cash flow. AAPL was expensively valued again in the fall of 2018, at 15.8x cash flow. Just a few months later it was down from $233.50 to $142. At the bottom of that cycle it was available for just 9.3x cash flow. Now, with AAPL about to split once again investor enthusiasm has run rampant. It now sells for 31.9x fiscal 2020's estimated cash flow. That's the priciest valuation for Apple in decades. We know AAPL was available for 7.9x to 9.3x cash flow at its three best entry points since 2009. Prior to this year it never exceeded 16x cash flow during those years. A reversion toward the mean P/CF of 15x, which is still a bit higher than average for AAPL, only would justify a $276 target for the end of fiscal 2021, which is about 15 months out. Prudent traders should be dumping Apple while it's overheated. They'll almost certainly have chances to buy back the stock at substantially cheaper prices later on, just as traders who bailed near previous valuation tops did back in 2012, 2015 and 2018. If you choose to stay with AAPL at this price (near $500), don't say you weren't warned. Virus-related travel restrictions have made recreational vehicle (RV) sales and rentals hotter than ever before. Thor Industries turned on a dime after plunging in March to just 5.2x this year's expected cash flow, at $32.30 per share. It recently rebounded to north of $121 before settling back to $107.26. The red and green stars tell the story. Buying THO at 4.8x to 8.8x cash flow always has proved to be a winning trade. Holding onto it when enthusiasm got too high and its P/CF ran up was disastrous. Noting THO's price in relation to its Value Line would have told you that at a glance. At present it appears somewhat overvalued. The next two stocks illustrated - The Children's Place and Alliance Data Systems -- appear to be huge bargains based on cash flow ratios. PLCE's March low was more extreme than where it fell to at the absolute worst moments of 2008-2009. Unsurprisingly PLCE then rallied from $9.25 to about $58 in less than three months. Since June 8, though, it has pulled back significantly. As of Aug. 23 it was selling for just $21.83, about 4.3x this year's much-reduced cash flow estimate. Its stores have reopened. Value Line sees fiscal 2021 cash flow growing from $5.25 to $8.55, which should get traders very interested again. My conservative 18-month target price sits near $77 and might prove way too low. After all, PLCE topped out above $110 during each of the four years 2016 through 2019. The children's apparel retailer's balance sheet is healthy, dividends are likely to be resumed and upside potential appears enormous. I added greatly to my position last week seeing the second chance to buy at $21 to $22 as a gift. ADS has a similar history. The company is having a down year but not a bad one, considering the shares fell from the $200 to $300 range into the $20s. Buyers near its March low have seen its price more than double in just a few months. The shares remain almost as low on a P/CF basis as they were near the March 2009 bottom. Brave souls with contrarian bents watched the stock climb from $22.80 to $312 over the next half-decade. Management tendered for $750 million in stock last summer at $148.50. Based on a normalized P/CF valuation ADS could easily be back to at least that range within 18 months. From last Friday's close of $43.19, that would represent better than a triple gain. Here is the basic data for Starbucks , Equifax and ABM Industries so that readers can have a go at working the numbers for themselves. SBUX closed last week at $77.16, EFX was at $159.33 and ABM was offered at $37.22. Take a shot at making six- to 12-month price targets on these based on what we've just covered. Are they attractive or to be avoided? Feel free to let me know in the Comments section.

Using Cash Flow Instead of Earnings to Figure Price Targets

Cash flow can provide an easy way of seeing whether a stock looks cheap or expensive.

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