Free cash flow favorites in technology

by Richard Moroney, editor Dow Theory Forecasts

In addition to the better-known price/earnings ratio, we like to use price/operating cash flow and price/free cash flow to value stocks relative to their cash-generating ability.

We screened for stocks that have grown operating cash flow and also look cheap relative to both operating cash flow and free cash flow. Three free cash flow favorites are Agilent Technologies (A), Google (GOOG) and Oracle (ORCL).

Agilent Technologies, a maker of measurement and testing equipment, illustrates the virtues of cash flow. For eight consecutive quarters, it has grown both operating cash flow and free cash fl ow at least 35%.

Some of that cash went toward the repayment of long-term debt, but much of it remained on the balance sheet, lifting net cash per share to $3.82 from a negative $1.17 two years ago.

The confluence of surging operating momentum and a revitalized balance sheet encouraged management earlier this month to initiate a quarterly dividend of $0.10 per share.

Better yet, the stock hasn’t kept up with that cash-flow growth, despite rebounding 49% from its October low.

Shares trade at 12 times trailing cash provided by operations, a 25% discount to their five-year average. At 14 times trailing free cash flow, the stock fetches a 29% discount to its peer-group average.

Agilent seems poised to deliver more growth, with the consensus projecting 15% higher per-share profits in the January quarter. Revenue growth is likely to exceed 8% for an eighth consecutive quarter.

Agilent has a history of managing Wall Street expectations, having topped the consensus profit estimate in each of the last 10 quarters.

Scoring above 50 in all six categories in our quantitative ranking system and earning an Overall rank of 97, Agilent is a Long-Term Buy.

Google shares retreated after the company said it earned $9.50 per share in the December quarter excluding special items, up 9% but $0.99 short of the consensus estimate.

Revenue increased 25% to $10.58 billion while cash provided by operations rose 11% to $3.92 billion, marking the 10th straight quarter of growth for both metrics.

The number of clicks on Google’s search ads surged 34% in the quarter, but the average cost per click — what Google charges advertisers — dipped 8%.

Rates for mobile ads tend to be lower than those for traditional digital ads, causing some analysts to wonder if the shift toward smartphones will cannibalize Google’s more-profi table business.

And some worry that Google is squandering its prodigious cash hoard — $44.63 billion at the end of 2011 — on Google TV and other unprofitable indulgences.

However, CEO Larry Page has worked to weed out superfluous ventures since taking the helm last April.

And some of those pet projects might begin to pay off. Social networking site Google+ experienced a 125% surge in membership to 90 million users in the last three months of 2011.

Moreover, operating cash flow consistently exceeds net income — affirming the quality of Google’s profi ts. The stock remains a Focus List Buy and a Long- Term Buy.

Oracle is one of just eight companies in the S&P 500 Index that has produced at least 5% higher operating cash fl ow in each of the last eight fiscal years (Google also accomplished that feat).

Given Oracle’s size — only five U.S. technology companies have produced more operating cash flow in the past 12 months — it is impressive that the company keeps finding ways to move the needle.  

Operating cash flow soared 45% in the 12 months ended November, nearly double its five-year annualized growth rate.

Some of that cash funds Oracle’s aggressive acquisition campaign, but cash assets have also climbed 25% in the past year to $31 billion, while long-term debt has held steady at roughly $15 billion.

Up 11% in so far in 2012, Oracle shares are within 3% of their price in late December, when company reported disappointing November- quarter results.

At 13 times free cash flow, shares trade 19% below their five-year average and 22% below the average systems-software stock in the S&P 1500 Index.

Based on operating cash flow, the stock looks even cheaper, trading at a 22% discount to its five-year average and 34% discount to its peer-group average. Oracle is a Buy and a Long-Term Buy.

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