By JACK HOUGH
Companies whose shares trade on Wall Street report their winnings to the public each quarter -- not once, but twice. Stock investors tend to obsess over one measure, earnings. Bankers tend to watch another, free cash flow. Stock investors ought to watch both, however, because differences between them can help predict future returns.
Free cash is easy to understand. It's the amount of money a company takes in each quarter (or pays out). Earnings are the funds a company would clear if, among other things, its costs paired off neatly each quarter with related revenues. In reality, companies often pay for raw materials in one quarter and sell them as finished goods in another, and they make lump-sum investments in plants and machines that generate cash over many years. Free cash flow is lumpy but real, while earnings are tidy but contrived. Over time, the two measures should tell roughly the same story. In the short term, they can differ by a lot.
Crucially, research by Richard Sloan at U.C. Berkeley and others suggests earnings are more likely to revert to the level of free cash flow than the other way around. In other words, for a company that's reporting $1.50 a year in earnings while clearing only 80 cents a year in free cash flow, there's a good chance that earnings are headed for a tumble. Since the herd tends to price shares according to earnings rather than free cash flow, shares of such a company are likely to disappoint, too. The opposite is also true. Companies with ample free cash flow but skimpy profits tend to report robust earnings growth in coming quarters, and their shares tend to outperform.
Below are listed three companies with free cash flow over the past year that exceeded paper earnings by at least 20%. Each pays a dividend and increased its sales last quarter.
P.F. Chang's China Bistro
Free cash flow per share (past four quarters): $3.28
Earnings per share: $2.10
Dividend yield: 2.1%
P.F. Chang's (PFCB)
Free cash flow per share: $11.96
Earnings per share: $6.81
Dividend yield: 1.3%
Looming health care changes will result in millions of more customers for private insurers, but are also meant to force insurers to spend an adequate portion of their premiums on care. Is that a net positive or negative for the industry? If you're in doubt, look at Aetna (AET),
Free cash flow per share: $1.70
Earnings per share: $1.24
Dividend yield: 1.0%
Waste Connections (WCN)