Identifying cashflow quality important for good stock selection

Our investment process identifies three qualities in a company: strong cashflow returns from its operating assets, better-than-expected earnings growth and ignorance of the first two.

We apply two cashflow ratios to over 1,000 European companies to identify stocks with these qualities before carrying out a detailed review of their report and accounts. Around 80% of companies in Europe have December financial-year ends. Since the cashflow ratios in our investment process are updated using audited financial information, most of which becomes available between the end of February and late May, we conduct a full annual review in this period. The changes this year have led to an increase in concentration in stocks and a reduction in the level of turnover compared to 2008. ...