At a time when Covid-19 has deprived so many operating executives of any meaningful transparency into their businesses, traditional profitability metrics are likely to become even more important to investors.
To help investors think through an opaque investment landscape and economic cycle, Goldman Sachs recently provided clients with a list of companies that are generating loads of cash, generally considered a sign of a well-run company.
“Strong cash generation, and the ability to convert accounting net earnings into free cash flow, generally implies high rate of deleveraging for the company (lowering risk for the firm, particularly downside risk) or the ability to distribute this cash to shareholders,” the bank’s derivatives strategist, John Marshall, recently wrote in a trading note.
The bank screened companies in its research universe to identify strong cash returns on cash invested, or CROCI, relative to the weighted-average cost of capital, or WACC, and robust free-cash conversions. And the resulting company list is intriguing because it includes many stocks that aren’t often part of the general market discussion. This suggests that they could prove to be hidden gems, or underappreciated businesses, in a market that remains heavily focused on major technology stocks, including Alphabet (GOOGL), Amazon.com (AMZN), Apple (AAPL), Tesla (TSLA), and Netflix (NFLX).
The trading menu includes PPG Industries (PPG), S&P Global (SPGI), Philip Morris International (PM), SBA Communication (SBAC), Analog Devices (ADI), American Tower (AMT), Gartner (IT), Microsoft (MSFT), Keurig Dr Pepper (KDP), Berry Global (BERY), Microchip Technology (MCHP), Keysight Technologies (KEYS), Science Applications (SAIC), Citrix (CTXS), Extra Space Storage (EXR), Xilinx (XLNX), KBR (KBR), Qorvo (QRVO), Autodesk (ADSK), ANGI Homeservices (ANGI), and Etsy (ETSY).
Such lists are interesting because they show a substratum of the stock market that is often not even noticed by the majority of investors who are focused on the momentum of top names. The list, however, is best used as a curiosity. If a name strikes you as intriguing, do some research to learn more, and then consider “renting” the stock with a bullish call option if a trade is merited, which is how many institutional investors handle such trading menus.
Though the stocks Marshall has identified have performed reasonably well compared with the S&P 500 index, the options market is more bearish on what comes next, implying that bullish call options are attractively priced.
Consider Etsy, an online crafts marketplace. Goldman Sachs advised clients to buy a call option with a strike price just above the stock price, and to focus on options that expire in three months.
With Etsy’s stock at $120, the December $125 call cost $14.50. If the stock is at $150 at expiration—say because of great holiday sales—the call is worth $25. If the stock is below the strike price at expiration, the trade fails.
During the past 52 weeks, Etsy stock has ranged from $29.95 to $141.41. The stock is up 184% this year and 138% over the past year.
The performance is incredible, and yet it still merited inclusion on Goldman’s list of companies with attractive cash-flow characteristics that often appeal to conservative investors.
Corrections & Amplifications
During the past 52 weeks, Etsy stock has ranged from $29.95 to $141.41. The stock is up 184% this year and 138% over the past year. An earlier version of this article incorrectly said that the stock had ranged from $117.77 to $123.32 over the past 52 weeks, and that it was up 170% this year and 126% over the past year.
