Why Cash Flow Is So Important to Income Stocks

When those in the mainstream financial media talk about stocks, they obsess over earnings reports. But there are many other important metrics to consider in stock selection. When it comes to income stocks, one metric is arguably much more important: cash flow.

In the video below, Oxford Club Editors Marc Lichtenfeld and Steve McDonald explain why it’s such a crucial metric for dividend investors.

Marc starts by explaining that cash flow is different from earnings. It’s a very simple measure of how much money a company is taking in. There’s not a lot of accounting involved in calculating it.

What’s more, it’s a measure of how much money a company has to pay for dividends, share buybacks and other important actions. That’s why it’s an invaluable metric for evaluating income stocks.

Marc goes on to point out that cash flow is often more volatile than earnings. Cash flow statements aren’t edited by accountants the way earnings reports are. And as a result, the metric’s volatility can be very revealing.

If cash flow and earnings are moving out of sync, that can be a sign of accounting shenanigans or other internal problems.

According to Marc, an income stock isn’t worth considering unless it has sufficient cash flow to pay its dividend. And the best income stocks (the “Perpetual Dividend Raisers”) increase their cash flow every year.

Cash flow statements are easily found at your favorite financial data source. Usually, they can be accessed on Google Finance or Yahoo Finance. Failing that, you can always go to a company’s investor relations webpage.

Two of the most useful items on a cash flow statement are cash flow from operations and free cash flow. The former measures how much cash a company is generating by running its business. And the latter just subtracts capital expenditures. You may recognize the term “free cash flow per share growth” from our Stock Grader series.

As you can see, cash flow is the most important metric you’ve never heard of… especially for income stocks. Dividend investors should keep an eye on this metric for a very simple reason. As Steve puts it, “if you’re out of cash, you’re out of business.”

— Investment U Research Team

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Source: Investment U