This week's screen follows the money: cash flow, that is. Our low-debt, high-cash-flow picks are also attractive to private equity hunters, though
From Standard & Poor's Equity ResearchTo manage a business successfully for the long run, companies need to generate cash and keep debt low. Debt is certainly a hot-button issue right now, with talk of a credit crunch brewing as companies find it more difficult to borrow money at higher interest rates and stricter lending terms. Low debt (or leverage) not only keeps a company's interest costs down, it also gives it more flexibility to invest its hard-earned cash back into the business so that it can expand and develop new products.
Cash flow, which is calculated by adding a company's net income plus depreciation, depletion, and amortization, is one of the key measures that many fund managers and investors look for when picking stocks. Companies with consistent cash flow can finance their own growth, and therefore can stand on their own two feet.
Potential Buyout Candidates
That brings us to this week's screen. We hunted for companies with low debt, high cash flow, and an attractive valuation—a recipe that just so happens to be private equity investors' dream.
Within Standard & Poor's U.S. equity database, we singled out issues falling in the lowest 20% in price-to-cash flow and debt-to-capital. In addition, we required them to have a price-to-earnings growth (PEG) ratio between 0 and 1.5, which is the market median.
We also wanted stocks currently trading above $5, with a market capitalization between $500 million and $10 billion. A lower market cap makes it easier for a buyout firm to acquire a company. Keep in mind that although these companies have the characteristics that private equity investors look for, they may not actually be takeover candidates.
Only four stocks fit the bill (for more information, open the ticker links):
Low Debt, High Cash
Makes cyberknife robotic radiosurgery system for tumor treatment
Makes software that tracks businesses' purchases from suppliers
Blue Coat Systems
Makes hardware appliances and software for controlling and securing Web-based communications
Provides enterprise software to financial-services, telecommunications, and retail companies