The top 10 ASX stocks to buy following the crash

The top 10 ASX stocks to buy following the crash.

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With a number of recent crashes in our stock market, there are a lot of great opportunities to buy stocks at bargain prices but, you need to know what to look for.

One of the problems for most investors is the emphasis placed on a company's profits (earnings).

Anyone remember Enron?

I'm not saying profits are not important, clearly they are but Enron is one example of what happens when the investing community is guided by all the wrong numbers.

Enron was profitable, if you believe its earnings reports. Its reports showed that the company's earnings were positive in 15 of its final 16 quarters, and we know what happened next!

Yet despite lots of these examples, there are still a number of retail investors, analysts, and financial media outlets that remain fixated on earnings.

Many of the brightest minds in finance, however, including Warren Buffett, pay closer attention to a different measure of corporate performance – free cash flow.

It may surprise you to know that there are a number of ASX listed companies that record profits but don't generate any positive free cash flow.

Likewise, there are a number of ASX listed companies that don't record profits but generate loads of positive free cash flow.

Why is free cash flow important?

Free cash flow is always important, but particularly in periods of high volatility, like right now.

Free cash flow (FCF) is defined as the cash that is available to all the company's investors, including shareholders and bondholders, after the company has made all investments necessary to sustain its 'ongoing' operations.

FCF is a key metric because it's a much more accurate measure of how much cash a business actually has left over to service debt, pay dividends, invest back into its operations or buy back shares.

Companies that produce consistently high and growing levels of FCF are unlikely to go broke any time soon.

Free cash flow however, can be difficult for most investors to calculate.

For most investors, especially those new to investing, it's very difficult to calculate free cash flow, so one 'trick' I use is to look at the 'cash flow after investing' to determine how much cash is left over to pay down debt, pay for dividends, buy back shares or reinvest cash back into the business.

Cash flow after investing is easy to calculate and will also tell you which companies had to borrow more money or raise new equity in order to cover any 'funding gap' left over after 'cash flow from operations' and 'cash flow from investing'.

So how do you calculate cash flow after investing?

Simple! We'll use Woolworths Limited (ASX: WOW) as an example.

First, we go the 'Consolidated Statement of Cash Flows' on their 2015 Annual Report:

wow1-min

We start with the 'net cash provided by operating activities' which is $3,345 million. It is very important to note whether this number is positive.

Then, we subtract the 'cash flows from investing activities' which is $1,333 million.

This leaves us with cash flow after investing of $2,011 million.

This is the cash flow after investing that Woolworths can use to pay down debt, pay dividends, buy back shares, or invest back into its operations. If this number is negative, this may be a red flag, or the company may be in a stage of acquiring other businesses. Either way, its important to keep an eye on this figure if it is negative.

So what does Woolworths do with this positive cash flow after investing?

It paid out dividends of $1,538 million:

wow2-min

It also paid another $42.8 million for 'Other financing cashflows', which included 'transactions with non-controlling interests' ($13.5 million), dividends paid to non-controlling interests ($28.8 million), and 'movements in employee share plan loans' ($0.5 million):

wow3-min

I have also added back Woolworths' 'foreign exchange effects' of positive $10.4 million:

wow4-min

This still leaves the company with a cash flow surplus of $440.2 million to pay down debt, buy back shares or invest back into its operations.

Companies with a cash flow surplus after paying dividends are the types of businesses that we love generally but particularly in periods of high volatility, like right now.

Here's a list of the top 10 cash flow generating companies after they have paid out their dividends. I've included a couple of other metrics to provide a degree of safety:

  • Return on Equity – Greater than 10%. Companies with sustainable competitive advantages should achieve above average returns on reinvested capital
  • Total Debt to Equity – Less than 40%. Less debt is better, especially when combined with a high ROE above
  • Market Cap – Greater than $300 million – We want to focus on mid and large-cap companies on the ASX
  • Dividend Yield – Positive – We are only interested in companies that pay dividends, but more importantly, generate enough cash to be able to sustain their dividend payments into the future
  • Foreign Exchange Differences – Cash flow figures include any net foreign exchange differences
Ranking Company ASX Code Cash Flow Surplus after dividends (Millions) Debt/Equity (<40%) Return on Equity (>10%) Dividend Yield (Positive)
1 Woolworths Limited (ASX:WOW) 440.2 31.05 23.86 5.51
2 Flight Centre Travel Group Ltd (ASX:FLT) 129.03 -80.04 21.67 4.1
3 BT Investment Management Ltd (ASX:BTT) 118.36 -7.78 20.24 3.74
4 CSR Limited (ASX:CSR) 96.9 -5.97 10.49 6.29
5 Austal Limited (ASX:ASB) 95.6 3.15 10.73 1.88
6 Northern Star resources Ltd (ASX:NST) 93.2 -46.7 37 2.54
7 Independence Group NL (ASX:IGO) 92.82 -20.49 12.36 2.8
8 Sandfire Resources NL (ASX:SFR) 87.19 -5.71 22.61 2.23
9 Platinum Asset Management Limited (ASX:PTM) 74.28 -93.67 59.03 6.89
10 Magellan Flagship Fund Limited (ASX:MFF) 56.45* -115.48 32.52 1.05

(Source: Company reports).

** MFF does not record cash flow after investing. It had (-$62 million) in cash flow from operations, other financing of $124 million, and paid dividends of $6 million leaving a surplus of $56 million.

Motley Fool contributor John Hopkins owns shares of Flight Centre Travel Group Limited. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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