Firms Invest In Their Business
Among the factors we consider when evaluating a companyâ€™s growth potential and underlying operating momentum, the trend in cash flow is one of the most important. But we also care about how that cash is ultimately deployed.
Enter the statement of cash flows, which shows how changes in the balance sheet and income statement impact the flow of cash in and out of a firm. The cash flow statement also illustrates the trend in capital expenditures.
Companies investing in plants and equipment presumably set the stage for growth that can translate into higher sales and earnings down the road. And in recent quarters, firms have opened the spigot. For S&P 500 companies in the 12 months ended September, total capital spending jumped 30% while cash flow rose 14%.
A companyâ€™s ability to produce attractive returns on its assets also has a major effect on long-term growth. Return on assets (net profit divided by average total assets) indicates how well management uses its plants and equipment to create earnings. All else equal, the lower a companyâ€™s return on assets, the more it needs to invest to generate another dollar of profit.
The table below lists six Buy-rated companies that have posted solid increases in cash flow and capital expenditures. In addition, all six have achieved returns on assets that outstripped their peer group and their own three-year average. One standout is reviewed below.
Business and cash flow are booming at Apple ($411, AAPL). Revenue jumped 66% and per-share earnings surged 83% in fiscal 2011 ended September. As a result, operating cash flow more than doubled to an impressive $37.53 billion, while cash payments for capital expenditures nearly tripled to $4.26 billion. The company spent more than $600 million on retail store facilities, with the remainder on manufacturing equipment, real estate, and general infrastructure. For fiscal 2012, capital spending is expected to reach $8 billion.
Brisk sales of iPhones, partly fueled by upgrades from Sprint subscribers, along with robust demand for iPads bode well for growth. Apple has an enviable position â€” it controls the software design and manufacturing of the iPhone and benefits from transactions via its App Store. The company is expected to announce two new tablet computers in coming months. For fiscal 2012, the consensus calls for per-share-profit growth of 26% on a 29% sales gain. At less than 12 times estimated year-ahead earnings, the stock seems undervalued given the companyâ€™s operating momentum. Apple, which earns the maximum Quadrix Overall score of 100, is a Focus List Buy and a Long-Term Buy.