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It was an uneventful week for the companies in the Orange Portfolio, but there was plenty of important action in the rest of the market.

In this update, I'll show you two stocks that took a dive last week, and why one of them is a potential candidate for the Orange Portfolio and the other isn't. I'll also tell you about a couple of stocks on my watchlist that I'm close to buying.

This retailer isn't priced right
Abercrombie & Fitch
(NYSE: ANF  ) is primarily a U.S. retailer, but it does get 21% of sales from its international stores. The shares tumbled 15% after second-quarter earnings were released last week. That's the kind of move that makes me curious enough to dig in, and if I saw the international operations as a long-term growth driver, I might consider the company for the Orange Portfolio, but with second-quarter comparable store sales at international stores down 26% I can't say that's the case.

More concerning is how operating cash flow at Abercrombie & Fitch has been in decline over the last three years even though capital expenditures have doubled. Over the past 12 months, capital expenditures exceeded operating cash flow, and the higher expenditures are quickly driving down the company’s return on invested capital. That's a terrible performance, and it's why the shares aren't the bargain they might appear to be after falling 50% in the past year. 

I'll eventually add a retailer to the Orange Portfolio, and the three companies I'm watching right now are Fast Retailing (OTC: FRCOY.PK), H&M, and Industria de Diseno Textil -- best known for its Zara brand. Fast Retailing is on my watchlist for its growth potential in Asia and North America, but at 14 times operating cash flow, it's priced a little bit higher than I would like to pay.

Almost time for more than a sip of this coffee
(Nasdaq: SBUX  ) shares fell more than 10% after earnings were released and continued their decline last week. Starbucks also gets more than 20% of its sales from international stores, but like Abercrombie, it's driven more by what happens in the U.S. than overseas.

Starbucks, though, is a cash flow machine, and it has nicely grown its operating cash flow the past few years, while capital expenditures have come down as store openings slow. That means a big boost in free cash flow, but it also means future growth won't be as fast as it was in the past.

At $44 a share, Starbucks valuation doesn't quite match up with the slower growth I expect from it in the future. But if the shares fall below $40, I would consider adding them to the Orange Portfolio because the brand still has potential to expand -- just more slowly -- and the dividend will grow more quickly than earnings and cash flow over the next five years, I think. In the current yield-deprived environment, the importance of a quickly growing dividend can't be understated.

Portfolio developments
After its recent run-up to over $46 a share, PotashCorp (NYSE: POT  ) has pulled back below $43. That's close to where I'd like to buy it, so hopefully that opportunity will develop in the next week or two.

On Tuesday, we'll get second-quarter results from Arcos Dorados (NYSE: ARCO  ) . I'm looking forward to seeing how management has handled the dual challenges of a strong dollar and softening Brazilian economy. Look for my review!

You can follow along with all my real-money Orange Portfolio trades and updates here.

Nathan Parmelee is a co-advisor of Champion Shares Pro and Share Advisor in the U.K. You can follow his real money Orange Portfolio here and his Twitter feed at @GlobalFools. Nathan owns shares of Potash and Arcos Dorados. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Related Tickers

10/21/2016 2:09 PM
ANF $15.69 Down -0.05 -0.32%
Abercrombie and Fi… CAPS Rating: *
ARCO $6.13 Down -0.03 -0.41%
Arcos Dorados CAPS Rating: *****
POT $16.41 Up +0.20 +1.23%
PotashCorp CAPS Rating: ****
SBUX $53.63 Up +0.04 +0.07%
Starbucks CAPS Rating: ****