- Progress on a potential vaccine for COVID-19 has kicked off a big rally in neglected value stocks this month.
- Deep Mehta of Goldman Sachs says companies with improving free cash flow margins and yield could be some of the strongest performers in that trend.
- The companies on Mehta’s list are all “Buy” rated, and he says their cash flow metrics will rebound in 2021 and get even better in 2022.
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Say that 2021 really does become a banner year for value stocks — the low-priced, long-neglected, unfashionable stocks that keep bringing up the rear behind everyone’s favorites.
Say it happens, since there are signs it could be starting already. Which stocks then look like the biggest winners?
To answer that question, Deep Mehta of Goldman Sachs turned to one of the things value investors have always prized: company cash flows.
Mehta says he’s identified some promising potential investments based on two measurements of free cash flow, a standard way of looking at a company’s profitability. The first is free cash flow margin, or a company’s free cash flow divided by sales, which shows how effective the company is at turning sales into cash flows.
The second is free cash flow yield, which compares the company’s cash flow on a per-share basis to its stock price and can be used to determine if the stock is especially cheap or expensive.
Mehta says he wanted companies where both metrics were going to be good and then improve as the recovery takes root.
“We favor strong operators where consistent free cash flow generation provides them with ballast and financial optionality,” he said.
The list that follows is made up of stocks with “Buy” ratings from Goldman Sachs that are forecast to post big improvements in both free cash flow margin and yield in fiscal 2021, and then build on that improvement with even better results in 2022.
Each company has at least $100 million in annual sales. Banks and master limited partnerships were excluded from Mehta’s analysis because those companies are evaluated by different financial metrics. These 14 companies are ranked from lowest to highest based on their expected free cash flow margin in 2021.