Seven Resolutions for the New Bull Market

Thumb-tacked over my desk is a chart of the value of the Long-Term Capital Management Fund, which quadrupled from 1993 to 1997, but was wiped out in a matter of months in 1998. I keep that chart to remind myself what can happen to an investor who forgets that it's not what you make during a bull market that counts, but what you keep during a bear market. I just finished my worst year in 20 years of investing -- down 20% in 2002 and down 27% from the market peak in March 2000. However, I'm still in business, which is more than I can say for many of my peers.

Is the bear market of the past three years finally over, setting us up for the next bull run? The pending war with Iraq clouds the near-term outlook, but I have the equity portion of my portfolios fully invested at this point. Perhaps you're thinking of coming back into stocks or increasing your exposure. Before you forget the lessons of this bear market, here's a clip'n'save list of resolutions for your next investments. Let's take a closer look at each resolution.

1. Cash Flow Is King

In a healthy company, there's more money in the till at the end of each year. The healthiest companies accomplish this by producing profitable revenues, not through financial engineering. Of the three standard accounting reports (Balance Sheet, Income Statement, Statement of Cash Flow), only the Statement of Cash Flow "shows you the money." The three components of the report are:

Cash Flow from Operations (sales minus cost of goods and services sold).

Cash Flow from Investing (usually negative from investing in Plant, Equipment, buying other companies).

Cash Flow from Financing (positive if a company issues debt or equity, or borrows money).

The least risky companies are the ones that can cover cash flow needs out of operations. In the latest quarterly report of Microsoft (MSFT - commentary - Cramer's Take) for example, we see that $6.2 billion in cash from operations funded $0.9 billion in investments, while $3.0 billion was spent to buy up stock, leaving a net gain in cash of $2.3 billion (Microsoft has other risks, so don't buy the stock just based on the cash flow report).

I wrote about the statement of cash flow in detail in March 2000 and analyzed the riskiness of three stocks -- Budweiser (BUD - commentary - Cramer's Take), Amazon (AMZN - commentary - Cramer's Take) and Revlon (REV - commentary - Cramer's Take) and here are the results:

Although Amazon's stock did as badly as Revlon over the last three years, at least Amazon survived while its cash flow negative peers went out of business. Make sure as you add new stocks to your portfolio that they have the cash flow to survive the next downturn.

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David Edwards is a portfolio manager and president of Heron Capital Management, a New York management firm. Edwards was a contributor to Harry Domash's Fire Your Stock Analyst: Analyzing Stocks On Your Own available at Amazon. At the time of publication, his firm was held positions in Dell and Amazon.com, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Edwards appreciates your feedback and invites you to send it to David Edwards.