If nothing else, the Standard & Poor’s Compustat study serves to underscore a basic business principle that has until recently been ignored by promoters of “new era” economics. That is, every viable concern must sooner or later produce consistently profitable top-line growth–even New Economy paragons like Amazon.com. Who knows? It may be only a matter of time before all that’s Old Economy is new again.
Ronald Fink is a deputy editor of CFO.
When Cash Flow Really Counts
The wide variation in shareholder returns produced by the companies in the Standard & Poor’s Compustat study suggests that investors don’t necessarily care if growth in operating cash flow trails that of earnings. Nonetheless, analysts contend that the gap can be a useful measure of operating performance.
While cash flow may move in a different direction from earnings in one period, a pattern typically develops over the course of two or three years, says Howard Schilit, president of the Rockville, Maryland-based Center for Financial Research and Analysis Inc. “We look for changes in the pattern,” says Schilit.
But what amount of change raises a red flag? “There’s no rule of thumb on what is normal,” says Schilit, “but if you look at enough graphs, you can spot something.” He cites the case of Oxford Health Plans Inc., whose stock plunged more than 62 percent on a single day in October 1997, after the HMO said it would report a loss. Schilit had warned his clients ahead of time. “Cash flow and net income had moved pretty much in sync,” he recalls. “Then we noticed a break in the pattern, where net in-come continued rising while cash flow from operations dropped like an anchor.”
Other analysts say that investors will pay more attention to operating cash flow if the recent market slide continues. “I think if we get into a slow period in the economy, people will focus more on cash flow,” says Chuck Hill, president of First Call/Thomson Financial Research in Boston. “So those companies where there is a gap [between earnings and cash flow] are probably not going to make out as well.” —R.F.
Where the Gaps Are
The 100 companies in the S&P 500 with the widest growth gaps between net income and cash flow from operations, 1997-2000.
For “date of data”: Results are for 12 consecutive quarters ending in the quarter indicated, the most recent quarter for which data was available at the time of the study. Some numbers may not add up due to rounding.
For comparison with the “3-year shareholder return,” the total shareholder return for the S&P 500 from March 31, 1997, to March 31, 2000, was 107%.
Source: Standard & Poor’s Compustat