Fortescue Metals Group, Qantas, and Primary Health Care are among the best stocks to own on a free cash flow basis, according to UBS.
Subscribe now for unlimited access.
$0/
(min cost $0)
or signup to continue reading
Free cash flow is defined as operating cash flow minus capital expenditures. Many analysts believe it is a more accurate measure of a company's performance than earnings – which can be distorted through accounting biases – and dividend yield.
"Ultimately, cash flow is what matters to investors," said UBS strategist David Cassidy in a note to clients.
"We believe a focus on free cash flow yield and free cash flow growth is particularly interesting at present given the market's preoccupation with dividend yields against a backdrop of low competing interest rates."
Companies that can grow their free cash flow "should ultimately perform well", he said.
"But companies trading on seemingly attractive dividend yields may not in all cases be able to grow those dividends, or worse still, may not be able to maintain them."
Mr Cassidy said the free cash flow assumptions for resources stocks were heavily influenced by commodity price assumptions.
Free cash flow estimates for resources stocks looked high, he said, because they were based on an ongoing oil price recovery.
However, the UBS analysis assumed less of a rebound for other commodities and, in the case of iron ore, a decline.
UBS carried out their analysis on S&P/ASX100 stocks with the exclusion of most financials as well as infrastructure trusts due to "complications in determining maintainable free cash flow", the paper said.
For banks, the complications included shifts in capital requirements and bad debt provisioning. For infrastructure and regulated utilities, dividends may not always be a good approximation of free cash flow, said Mr Cassidy.
The best-performing stocks in the report's key screens were:
- Current free cash flow yield, 2016 financial year: Fortescue, Primary Health and Qantas;
- Free cash flow yield relative to earnings yield, 2016 financial year: Fortescue, South32 and Primary Health;
- Free cash flow yield relative to dividend yield, 2016 financial year: Fortescue, South32, Primary Health and Tabcorp Holdings;
- Free cash flow growth from financial year 2016 to financial year 2018: Incitec Pivot, Illuka Resources, Crown Limited, Star Entertainment Group and Santos;
- Expected free cash flow yield, financial year 2018: Qantas, Incitec Pivot, Primary Health, South 32, Illuka Resources, Bluescope Steel, Santos, Woodside Petroleum.
