How Well Do You Use Cash, CenturyLink?

There are two parts to successful investing: finding the winners and avoiding the losers. Looking only for the former, especially if you focus mostly on revenue and earnings, can leave you exposed to the latter.

To fully benefit from your winners, you need to spot the stocks to stay away from. After all, a 200% gain is completely wiped out by four other picks that drop 50% each. As for that winner, revenue and earnings won't let you see trouble coming in time to do any good. You don't want to wait for an ugly earnings surprise that gives your stock a massive haircut before you get out.

That's why just about the first thing I read is the balance sheet. This is where the company's financial health is found, and where the warning signs of sickness often show up.

One balance sheet tool I like is the cash conversion cycle. This shows how fast the company turns its cash into inventory, sells that inventory, and then collects the cash on those sales. It's measured in days, and generally, the lower it is, the better. (For details on how it's calculated, check its Foolsaurus investing wiki entry.) It's possible to have a negative CCC, as Dell showed to great effect for several years. Of course, seeing CCC increase can mean that a company's worth avoiding or exiting.

This metric doesn't apply to every industry, however -- banks are a notable exception. It's primarily for companies that buy from suppliers and sell to customers.

Here are three companies operating in the same industry that recently caught my eye:

Source: Capital IQ, a division of Standard & Poor's, and author calculations. TTM = trailing 12 months. All numbers are in days.

Unfortunately for CenturyLink, even though it has a negative CCC (it gets paid by its customers before it pays its suppliers), the value has been increasing over every period presented. Verizon has actually driven CCC down, though it had been even more negative five years ago. The magnitude of that increase concerns me a bit. And the CCC situation for TDS is similar to CenturyLink's.

Of course, the cash conversion cycle should not be the end of your research; it's best to follow trends over time. However, it can provide useful pointers toward either getting in or staying away.

Go past the obsessive focus on quarterly earnings, and you'll find yourself way ahead of the vast majority of the market's individual investors. By learning to calculate and use the cash conversion cycle, you'll more likely spot a deteriorating situation early enough to either avoid the company in the first place, or escape before it "surprises" with a bad earnings report.