OPS Winners & Sinners
Record Index Highs for 2005

EQUITIES Magazine

Fall/Winter 2004

By Michael Markowski
Director of Research at StockDiagnostics.com.

The metrics of Free Cash Flow and OPS that StockDiagnostics.com monitors indicate a strong advance for the stock market in the first half of 2005. The Dow Jones Industrial Average is in the position to set new record highs and the Nasdaq 100 and S&P 500 are also set up for surges.

Why? Changes in Free Cash Flow are a good predictor of major stock market moves. For the 12 months ended October 31, 2004 Free Cash Flow for all three major indices hit all time records. Since 2002, Free Cash Flow is up over 100% for the S&P 500, over 70% for the Nasdaq and over 50% for the DJI.

In order to judge risk reward levels in the stock market investors should pay close attention to the aggregate Free Cash Flow for the major stock market indices. It is calculated by adding the Cash Flow From Operations from each of the companies making up a particular index and subtracting the total amount of capital expenditures. Both of these figures can be found on an individual company's Cash Flow Statement and are required to be filed quarterly with the SEC along with its Income Statement and Balance Sheet.

Aggregate Free Cash Flow negative momentum for the 30 Dow Jones Industrials, the S&P 500 and the Nasdaq 100 indices accurately predicted that a downturn in the economy had commenced before 9/11/01. Similarly the change in the Free Cash Flow momentum from negative to positive also signaled that the markets had bottomed in 2002.

Now for more history. Free Cash Flow for the S&P 500 hit an all time high in the 12 months ended January 31, 2000. Year over year growth comparisons turned negative six months later for the 12 months ended July 31, 2000. The S&P 500 Price Index was at 1430.83, less than 100 points from its all time high of 1529.18. The downturn was the first in a five quarter negative streak with each period showing negative comparisons to the year earlier prior period. The S&P broke out of its cash flow slump when its Free Cash Flow increased in its 12 months ended October 31, 2001 when compared to the same year earlier period. At that time the S&P 500 index was at 1059.01, over 150 points less than its latest close.

The DJI's Free Cash Flow hit an all time high in the period ended October 31, 1999 and year over year growth comparisons turned negative nine months later for the 12 months ended July 31, 2000 with its price index at 10,521.98. The downturn was the first in what would become a four quarter negative streak. With the index at 9,920.21 the DJI broke out of its slump when its Free Cash Flow for its 12 months ended January 31, 2002 went to an all time high. With the DJI most recently at 10,871.12, investors who made decisions based on the DJI's change in Free Cash Flow momentum would have participated in a 900 point gain.

The Free Cash Flow of the Nasdaq 100 lagged the S&P and the DJI, peaking in the 12 months ended July 31, 2000. Its first year over year decline after the peak began one year later on July 31, 2001 with its price index at 2027.13 and lasted for three quarters. Its Free Cash Flow recovered and hit an all time high in the 12 months ended July 31, 2002 with its index at 1328.26. By tracking its aggregate free cash flow investors would have avoided a 699 point down turn and also would have participated in the recent 841 point upturn.

Winners And Sinners
Shifting from macro to micro, our metrics indicate stock picks to outperform the market for 2005 are my favorite (See page 9) United Online (Nasdaq: UNTD 11.32), Netflix (Nasdaq: NFLX 11.69) and Sun Microsystems (Nasdaq: SUNW 5.47). Two stocks to avoid are Helen of Troy (Nasdaq: HELE 32.34) and Nacco Industries (NYSE: NC 105.21). -MM

Reprinted with permission from
EQUITIES Magazine - Fall/Winter 2004
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