Cashing In

Toronto's main stock index hit its lowest level in 12 weeks on Friday, pulled down by weak commodity prices after stronger than expected U.S. economic data sparked a rally in the greenback.

Unexpectedly strong fourth-quarter economic growth in the United States (GDP grew at a 5.7 per cent annual rate) and healthy November gains in Canada failed to lift investors’ spirits. The talking heads will tell you that plans by U.S. President Barack Obama to restrict trading by big financial institutions have spooked the market. The Toronto market, in particular, has been impacted by Chinese moves to curb lending by raising bank reserve requirements, which touched off concerns about commodity demand.

Having said this, with trailing valuations where they were and the markets posting meteoric gains since March of 2009, a correction is natural.

While it started off rather healthy, the last two weekly sessions conspired to drag the TSX about 5.5 per cent lower in January. For its part, the Dow Jones industrials average was down about 3.5 per cent over the month.

Despite the broader down market, in a stock picker’s market one company from our Canadian Small-Cap Universe (www.keystocks.com) showed us the value of selecting the right company.

This past week, The Cash Store Financial Services Inc. (CSF:TSX) announced strong Q2 financial results for the period ending December 31, 2009. The company, which operates under two banners; The Cash Store and Instaloans, serves as brokers to facilitate payday advance services to income-earning consumers. Since opening its first branch in 2001, the company has rapidly grown its network to 469 branches employing over 1,800 associates in more than 160 communities. By branch count, Cash Store Financial currently holds 25 per cent of Canada’s alternative financial services market and is the leading provider in Alberta, Saskatchewan, Manitoba, and Atlantic/Rural Canada.

For the quarter, revenue increased 14.3 per cent to $42.3 million from $37.0 million in the same period last year. The higher revenue reflected an increase in both brokerage fees and other services. This growth was due to 54 additional branches, the maturing of existing branches, and increased same branch revenues.

Net income for the second quarter was $5.5 million compared to $4.3 million for the same quarter last year. Diluted earnings per share increased to $0.32 in the quarter compared to $0.23 for the same quarter last year; a record $0.65 for the six months ended December 31, 2009, compared to $0.54 for the same period last year.

Shares in the company jumped over 15 per cent on the week to close at $12.02.

Looniversity - Free Cash Flow – Sound Good?

The best things in life are free – does the same hold true for cash flow? Quite simply, yes. Smart investors love companies that produce plenty of free cash flow (FCF). It signals a company’s ability to pay debt, pay dividends, buy back stock, and facilitate the growth of business – all definite positives from an investor’s perspective.

What Is Free Cash Flow?

By establishing how much cash a company has after paying its bills for ongoing activities and growth, FCF is a measure that aims to cut through the arbitrariness and “guesstimations” involved in reported earnings. Regardless of whether cash outlay is counted as an expense in the calculation of income or turned into an asset on the balance sheet, free cash flow tracks the money.

To calculate FCF, make a beeline for the company’s cash flow statement and balance sheet. There you will find the item “cash flow from operations” (also referred to as operating cash). From this number subtract estimated capital expenditure required for current operations. Voila, free cash flow.

While free cash flow is a great gauge of corporate health, remember it does have its limits and is not immune to a “slippery accountant.”

Put it to Us?

Q. I am thinking of buying a stock which is trading at its 52-week low. Is this a good strategy?

- Andy McFadden; Calgary, Alberta

A. Without knowing your individual investment profile and researching the specific company, no one (not even us) can answer your specific question. However, we can give you our consensus opinion.

In most cases, it is very dangerous to purchase any stock just because it is trading near a 52-week low (incidentally, there are quite a few with this dubious distinction in the current market). Think of it in terms of the old Wall Street adage, “Those who try to catch a falling knife only get hurt.”

For a more concrete example, look no further than Canada’s own Nortel Networks (NT:TSX) which, following the tech bubble, plunged from a high of over $125 to below the $1.00 range at one point over the past number of years. Think of the coinage you would have lost purchasing this gem every time it made a new 52-week low.

Price is only one part of the investing equation. The goal is to buy good companies at a reasonable price. Buying companies solely because their market price has fallen will get you nowhere fast. Remember, most companies trading near their 52-week low are there for a good reason.

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