Wednesday, January 28, 1998

The Daily Workshop Report
by Robert Sheard (TMF Sheard)

LEXINGTON, KY. (Jan. 28, 1998) -- With the imminent launch of Tom Gardner's Cash-King portfolio, it's been asked whether applying the Foolish Flow Ratio to the Keystone screen might make Keystone even more profitable than its twelve-year history suggests it can be. And my answer was simply, I don't know. I hadn't looked at such a combination.

This morning I began looking. For lack of time, though, I was only able to examine a single year so far, so I'm not going to make any claims one way or the other, but will simply lay out the results from 1997's inquiry and withhold judgment until more history has been examined.

The flow ratio Tom outlined last September is a way of measuring how aggressively a company manages its inventory and its cash. It's a simple ratio:

Current Assets - Cash 
 ---------------------- = Flow Ratio 
 Current Liabilities 
 

The theory is that the more cash and the less inventory, the better. So one wants a low flow ratio, preferably under 1.00. A flow ratio above 2.00 suggests too much inventory and too little cash.

This morning, I went back to the list of 30 Keystone stocks from the beginning of 1997 and calculated the flow ratio for each. Seven of the stocks -- the bank, thrift, and insurance stocks -- do not account for current assets and liabilities in the same fashion as other stocks, so I was unable to calculate a ratio for them. Unfortunately, this may have skewed the results against using the ratio since 1997 was a banner year for such stocks.

Then I ranked the remaining 23 stocks by their flow ratios, lowest to highest. Of that group of 23, twelve stocks had flow ratios of 1.00 or less. Over the course of the year, those twelve stocks had an average gain of 43.40%. The top five averaged 45.33% and the top ten averaged 45.92%. By way of comparison, the top five Keystone stocks returned 57% and the top ten returned 56%.

The eleven stocks with flow ratios above 1.00 averaged 32.65%. And while the big loser on the year, Nike <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NKE)") else Response.Write("(NYSE: NKE)") end if %>, was among the three stocks with the highest flow ratios (and thus was a good stock to avoid), the two stocks with the highest flow ratios of the entire group turned out to be two of the best performers of any of the Keystone stocks: Compaq Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPQ)") else Response.Write("(NYSE: CPQ)") end if %> with a 90.07% gain and Home Depot <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %> with a 76.90% gain.

I'm not willing to suggest, based on a single year's comparison, that the Cash-King Flow Ratio won't improve Keystone. But I'll have to pick Tom's brain on how one might use it with financial sector stocks so as not to overlook those potential winners. Last year, a healthy number of such stocks were atop the Keystone rankings, boosting the returns considerably higher than the market indices. Perhaps there's a way to apply some form of Cash-King test to them as well. I'm looking forward to the progress of his new portfolio. I love the simplicity of it and the power it's shown in the past when he's used it.

Stay tuned and Fool on!

[Want to be the first Fool on your block to get a copy of Robert Sheard's forthcoming book? Click here to pre-order your copy of The Unemotional Investor.]