The silver lining of all market declines is the chance to buy stock in quality companies at attractive prices. That opportunity has been notably absent over the last two years, which is why my focus has shifted to smaller and smaller companies in search of reasonable valuations over that time. Although I still don't believe the market is cheap by any measure other than comparing it to a couple months ago, the volatility is starting to bring some individual bargains, especially on heavy selling days.
For instance, I've started to acquire some of the waste management stocks that I looked at last week, although I'm still waiting on another round of selling to purchase others. In particular, I am looking for companies with high dividend yields that are well covered by free cash flow and earnings. I also want companies with low levels of debt to ensure that income would be relatively stable, even when revenues drop.
I like the waste sector because I think it will benefit as higher commodity and energy prices lead to more profitable recycling and waste to energy operations.
In contrast, the companies I'll look at today are not in any one sector, but rather they are broader industrial companies with a range of businesses in the clean energy arena that have drawn my attention over the years.
Because these companies are large and well covered by mainstream analysts, I don't feel that I have the resources to gain an informational advantage over other market participants. Instead, my strategy with companies like these is to wait until a general market downturn produces good valuations, and buy those companies which have decent dividends supported by healthy capital structures, earnings, and cash flow, with the intent on holding them for the long term.
In particular, I'm looking for a dividend yield around three percent or more, with earnings and Free Cash Flow (FCF) yields considerably higher than the dividend so that there is room for earnings and cash flow to fall without imperiling the dividend. I'm also looking for moderate levels of debt, preferring companies that are mostly equity rather than debt financed.
I looked at the following seven companies:
I compare the companies' dividend, earnings, and cash flow yields, and debt/equity ratios in the chart below.
Of the companies listed, only ABB, Deere, Siemens, GE, and Johnson Controls have even moderately attractive dividends. Of these, only ABB and Siemens have a level of debt I consider low enough to give it flexibility to cope with a sluggish world economy. Yet both these companies have uncomfortably low FCF to support their dividends. Free cash flow can be quite volatile, so I would want to take a closer look to decide on the cause of the current low cash flows at the companies before making an investment. Furthermore, neither stock is particularly attractive on the basis of earnings, since analyst's predicted growth may not materialize, and both trade near 17 times 2010 earnings.
Of all the companies I consider here, Roper Industries looks the healthiest, with strong alignment between earnings, cash flow and low debt. But as with ABB and Siemens, the current valuation is unattractive.
Especially when you consider that company analysts tend to be overly optimistic as a whole, we should probably discount the 2011 and especially 2012 earnings estimates. None of these stocks looks like a great value at current prices, despite having fallen between 12 percent (ABB) and 35 percent (AECOM) year to date.
I take the lack of great values as a sign that this market decline likely has farther to go.
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This article was originally published on AltEnergyStocks.com and was republished with permission.