Monday Dirty Dozen [CHART PACK]


All men dream: but not equally. Those who dream by night in the dusty recesses of their minds wake in the day to find that it was vanity; but the dreamers of the day are dangerous men, for they may act their dreams with open eyes, to make it possible.  ~  T.E. Lawrence

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Good morning!

In this week’s Dirty Dozen [CHART PACK] we walk through positioning indicators for the equity market and check out the worst 5-day fund flow streak for an ETF in over a decade. We then look at some dollar charts that suggest a short-term bottom in the USD may be near while the longer-term outlook doesn’t look so hot. We then end on a positive note for the broader US macro picture.

Let’s dive in.

***click charts to enlarge***

  1. UBS’s US Composite Positioning indicator, which measures the active manager positioning using a “proprietary database of over 930 MFs with AUM of $5.5trn across US equity MFs and allocation funds”, shows that the big players, on the whole, are under positioned risk. Though they’ve been aggressively working to correct this over the last couple of weeks.


  1. But that under-positioning has been somewhat balanced out by the speculative fervor that shows in the options market where Put/Call Ratio MAs (inverted) are at levels that create fragility and tend to preceded decent-sized corrections. One major reason why the odds favor a continuation of the move lower this week.


  1. Vanguards Total Stock Market Index (VTI) saw its largest 5-days of outflows in over a decade last week. Hmm…


  1. Copper is the market you want to follow for sniffing out early trends in global growth. A promising sign on that front is that the cash market / 3-month copper curve is close to flipping into backwardation. This implies a tightening market and likely higher copper prices ahead (chart via Bloomberg).


  1. According to CS 42% of Russel 2000 companies have negative earnings. That’s the highest on record. Now, there are two ways to look at this (1) wow, this is really bad or (2) huh, this is maybe as bad as it can get and perhaps a bottom is near for small-caps? I don’t yet have a strong side.


  1. This other chart from CS shows the differences in COVID trends between those states that opened early and those that didn’t. I get the sense that that COVID and the lockdown risk narrative might be coming back to the fore.


  1. In a recent note, DB pointed out the tightening supply dynamics in the oil market. They wrote “US oil production dropped by a very large -600kb/d this week equalling the 3 April decline, while the oil-directed rig count also fell by a further 10 rigs. Oil production from the US has now given up two full years of gains.” That’s quite significant…


  1. Here’s some good news. More US companies have been offering a brighter financial outlook than a gloomy one as the quarter comes to a close (chart via Bloomberg).


  1. Last week CS made the bear case for the dollar, pointing out its 1.5stdev overvaluation and the deterioration of the US’s net investment position over the last decade and a half.


  1. While I am sympathetic to the bearish USD case over the longer-term. I’m becoming quite concerned that the opinion is nearing a consensus — at least at the IB level, if not the broader market (yet). Plus, positioning is nearing levels that have marked short-term bottoms for the DXY in the past (chart via UBS).


  1. The Conference Boards Leading Economic Index YoY% recently turned up from its lows. Now, it’s too early to say whether this is a change in trend or just a bump along the road lower. But…


  1. If it is a change in trend then that’ll bode very well for the stock market. Because, when the LEI YoY is below zero and rising, the equity market tends to have its best average annualized equity returns — averaging 29.5%, which isn’t too shabby.



Stay safe out there and keep your head on a swivel.

Kura Sushi (KRUS): Restaurant IPO w/ Playbook for Success


Business Description: Kura Sushi USA, Inc (KRUS). operates revolving sushi bar restaurants in the United States. The company’s restaurants offer Japanese cuisine and a revolving sushi service model. It operates 24 restaurants in five states. –

The Thesis: KRUS is a patent protected, technology-first sushi restaurant. The company offers high quality sushi at low prices thanks to robotic rice makers, automated dishwashers and a conveyor-belt delivery system. Such technology enables KRUS to offer lower prices while maintaining strong operating margins. KRUS flies under-the-radar of most investors IPOing around $150M. Its parent company has over 30 years of success in Japan. We think KRUS can grow into a 300-store empire generating $50M in annual FCF.

Unique Dining Experience: KRUS is unlike any other sushi restaurant in the US. The food comes to your booth via a conveyor belt. There’s no waiters/waitresses to take your order. Everything’s done at your booth via monitors. Diners also receive in-restaurant rewards like prizes for ordering 15 plates of sushi. There’s also a mobile app to track your Kura rewards ($5 coupon when you spend $50, etc.). When you’re done eating, simply deposit each plate into the installed plate disposal mechanism at your table. Each plate travels into an automated dishwashing system, removing the need for bus-boys and additional staff.

Technology-First Restaurant: We know about the conveyor belt, rice makers and automated dishwashing systems. But there’s two other facets to KRUS technology that give it an edge. First, each plate of sushi has its own unique barcode. The dishwashing system scans the plate and records which type of sushi you ate. This data allows chefs/rice markers to optimize how much of each type of sushi to produce.

Second, KRUS has patented technology on Mr. Fresh, their conveyor belt sushi delivery system. Mr. Fresh is a dome that covers each plate of rotating sushi (the sushi you don’t specifically order). Each dome has an embedded chip that alerts the kitchen when a customer takes the sushi. It also monitors how much time that plate has spent on the belt (keeping items fresh).

What’s It Worth: There’s a few main drivers to increase per-share value: annual store growth, gross margin expansion and cap-ex % reduction. Using its parent company as a proxy, steady-state KRUS would generate 40% gross margins, 5% operating margins and ~6% FCF margins. Assuming 20% annual store growth, we end 2024 with $160M in revenue, $64M in gross profit, $8M in operating income and $9M in FCF. Let’s review what shareholder value would look like under three scenarios (bold = higher than current market cap):

Monday Dirty Dozen [CHART PACK]


You cannot trade the market. Instead, you can only trade your beliefs about the market. However, you can only do that successfully if you understand the fundamental concepts behind low-risk ideas, expectancy, and position sizing. ~ Van Tharp

In this week’s Dirty Dozen [CHART PACK] we look at a record high in the DIX index, giving a very bullish signal. We then cover the troubling change in COVID trend growth in some US states and what they could mean for markets. And finally, we end with some charts showing the historical value opportunity on offer in select European markets, plus more.

Let’s dive in.

***click charts to enlarge***

  1. This is an interesting chart from @MacroCharts. He tweeted “When the history books are written about 2020… Save a page for how Stocks plunged at the fastest pace ever – and nearly all News Stories contained the word “BUY” at the *exact* bottom.

“It may have been the ONLY time in history this ever happened. Time will tell… Yolo!”


  1. Three weeks ago I shared this DIX chart from @SqueezeMetrics pointing out that the index had hit an all-time high. Well, last week it once again broke that record. This is incredibly bullish as it shows large players are purchasing big blocks of stocks in off-exchange transactions. You can find more info on the DIX here.


  1. Bernstein published a report on US COVID trends recently where they point out the troubling trend in case growth amongst many US states. In the chart below, they show their projections for where daily new cases could be headed should this rise go left unchecked.


  1. This matters to the markets for a number of obvious reasons. One of them being that a rising case count raises the likelihood of a return to shutdowns. This chart from DB shows the relationship between market volatility and global case growth.


  1. COVID-19 has acted as an accelerant on many existing trends such as the rise of e-commerce. This chart from RBC Captial shows that despite the rebound in brick and mortar based shopping, the trend growth in online shopping hasn’t slowed.


  1. There’s a lot of funky charts out there that are just complete head-scratchers. Take this one from DB for example, the percentage of US consumers expecting the economy to be worse off in 6-months time is at its highest print in 10-years. At the same time, those expecting things to be better in half a year is at its highest level ever. I’d be interested to see how this splits out according to political leanings.


  1. On a similar note, we haven’t seen too many other times throughout history where consumer confidence (red line) and the market (white line) were this disconnected.


  1. Nearly 20% of US companies now classify as “Zombie Firms” according to DB. A business gets classified as a zombie when there debt servicing costs are higher than there profits. This is not good for a capitalistic system. We are seeing our markets disintegrate in real-time and it doesn’t seem like we have any reasonable people driving the bus, who could possibly redirect course from here.


  1. I’ve been pointing out the attractiveness of some European and EM markets in these pages over the last two months. Here’s a group of charts from MS that help make the bullish case for Europe.


  1. And within Europe, you might want to look at value stocks from the periphery seeing as how both groups are at or near historical record low valuations (chart via MS).



  1. Citi’s Bear Market Checklist is still not giving an imminent warning of a bear market. Their checklist is only showing a reading of 30% of red and amber signals. You need a reading of above 50% to signal a bear ahead.


  1. One of the strongest looking sectors from a technical standpoint right now is Biotech. The biotech index went out last week on its highs and at all-time highs at that. The space has also large outflows recently which is generally a bullish sign when combined with contrasting price action.

Stay safe out there and keep your head on a swivel.

The Narrative Pendulum

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Fractalized sine waves are encoded into the very fabric of our reality. Like the Golden Ratio and the second law of thermodynamics, they appear throughout the universe on nearly every level of scale and function. It’s no surprise then that they underlie the structure of our market.

This makes intuitive sense because a sine wave is just a continuously swinging pendulum. And crowd dynamics naturally follow the path of a pendulum. Swinging from one local extreme to another. 

The market is in effect a large complex information transmission system. All acting participants make bets using their particular knowledge set which then in aggregate sets the market price. This, then, provides new information for the actors to incorporate into their decision-making process so they can then make new bets. Thus, creating a neverending feedback loop of information, assessment, action, new information.  

These infinite feedback loops, when combined with group psychology and crowd dynamics, necessitate the constant back and forth we see in markets.

Each rally sows the seeds for a reversal and each reversal sows the seeds for a rally. Ad infinitum. 

Michael Mauboussin discusses how this dynamic creates a neverending process of market trends and crashes in a paper titled “Who Is On the Other Side?”. In it, he shares work done by economist Blake LeBaron which animates this concept using an agent-based model (here’s a link to the original paper). 

The model is computer generated and the “agents” are imbued with decision-making rules and objectives similar to those that drive market participants (i.e., make money, try not to lose money, don’t underperform the average for long periods, etc…) 

Here’s a section from the paper (emphasis by me): 

LeBaron’s model replicates many of the empirical features of markets, including clustered volatility, variable trading volumes, and fat tails. For the purpose of this discussion, the crucial observation is that sharp rises in the asset price are preceded by a reduction in the number of rules the traders used (see exhibit 5). LeBaron describes it this way:

“During the run-up to a crash, population diversity falls. Agents begin to use very similar trading strategies as their common good performance begins to self-reinforce. This makes the population very brittle, in that a small reduction in the demand for shares could have a strong destabilizing impact on the market. The economic mechanism here is clear. Traders have a hard time finding anyone to sell to in a falling market since everyone else is following very similar strategies. In the Walrasian setup used here, this forces the price to drop by a large magnitude to clear the market. The population homogeneity translates into a reduction in market liquidity. 

“Because the traders were using the same rules, diversity dropped and they pushed the asset price into bubble territory. At the same time, the market’s fragility rose.”


Really grokking this concept and understanding how this plays out in markets is critical to learning to play this game at the second and third levels and beyond. It’s the fundamental difference between being a reactionary self-proclaimed contrarian that routinely gets steamrolled by price-trends. And an effective contrarian, who knows how to read something I call the “Narrative Pendulum”, which allows you to get on and stay on the right side of the trend. 

I talk about this concept in-depth in a recent video I put together. If you’re interested in giving it a watch just click the link below. It’s free and doesn’t require anything on your end, other than just an hour of your time. But I promise the information is illuminating and will change the way you view and interact with markets in more ways than one.

Video: How To Read the Swing of the Narrative Pendulum

I’d love to hear your feedback after you’ve given it a watch. Just shoot me an email at with any Q’s and comments you have. I look forward to hearing from you!

The Hierarchy of Technicals


The hierarchy of market technicals looks something like this:

    1. Price: The tape is the first and final arbiter of truth
    2. Trend: Newton’s first law reigns. A trend in motion tends to stay in motion and a tape at rest, stays at rest
    3. Breadth: A measure of the strength and durability of the price and trend
    4. Hard Positioning/Sentiment: Quantitative measures of actual positioning in markets (ie, put/calls & CoT)
    5. Soft Sentiment/Data: Survey sentiment data, such as AAII and Investors Intelligence

Here’s how this works in practice.

Oh… and a quick reminder for those of you who missed it. I put together a free webinar where I dive deep into this subject + much more, which you can find here.

If you don’t know how to read the first one, then the other four can be dangerous facilitators of confirmation bias.

But… If you’ve developed an aptitude for reading the tape then the other tools can be great for helping with your timing and analysis of the potential amplitude of moves.

The idea is to use all the above tools holistically, as a means of providing context, and in their hierarchy of importance.

That’s what we’re going to do today. We’re going to run through some charts and see if we can put some puzzle pieces together to form a clearer picture of where we are.

I’ve purposefully left out any mention of more general macro data points. The current situation is too fluid with COVID on one end and record-breaking fiscal/monetary actions on the other, that I feel it detracts from the analysis at this point more than adds.

Until we see a semblance of consensus, I’ll trust that the market is smarter than me in discerning what the future holds.

We’ll start with the bottom and work out way up.

Soft sentiment data is rebounding from a very bearish consensus. Depending on which survey and what cohort you’re looking at, sentiment is either back near neutral territory, such as AAII Net Bulls-Bears, or has recovered completely to outright bullish levels such as we see in Investors Intelligence and NAAIM Exposure index.

Here’s a chart of AAII Net. It’s still showing fairly bearish readings considering the run in the tape. It’ll be interesting to see where the numbers are when they come out today.

This chart put together by @MacroCharts shows the net exposure to equities of fund managers surveyed in BofA’s latest FMS. They’ve reversed from decade-low exposure to near-decade highs in the span of a month. Nothing like a change in price to drive a change in sentiment.

The hard positioning data paints a more mixed picture.

For example, Put/Call ratios are showing extreme complacency. The vertical red highlights below show the prior three times that both the 5, 10, and 25-day moving averages were this extended — note, put/calls are inverted in the chart below.

Last week’s selloff didn’t put a dent in this measure. It’s going to take more volatility and fear to wash out these weak hands.

It’s important to point out though, this isn’t an exact timing tool. Rather, you should think of put/call ratios as a measure of trend robustness/fragility. When the measure is this extreme, it means that the trend in the price is becoming more fragile, unstable, and prone to larger more violent washouts. Vice-versa when the ratio is reading the opposite.

BofA’s Private Client Sentiment Indicator, which measures ETF positioning in “EM/DM, Value/Growth, Small/Large, Cyclicals/Defensives, Stocks/Bonds + cash levels” has bounced from its lows but is still at bearish levels. Speculative CoT data also shows something similar.

Breadth, on the other hand, has been incredibly strong since the March 23rd bottom.

A good way to think of market breadth is like an advancing military force. Strong breadth is similar to an army with a deep and disciplined line (this is old school battle where fighters stood shoulder to shoulder). That line has strength and weight behind it. It can move and push through barriers.

On the other hand, when the line is thin and begins to fracture. It doesn’t take much from the opposing force to break it completely. This is how major trend changes happen. Each issue in an index is equivalent to a soldier standing on that line. And that is what various indicators of breadth aim to measure.

This chart showing oscillating Breadth Regimes in the Nasdaq over the last 20-years is a great example.

The red boxes mark weak breadth regimes where the majority of issues are moving down and the tape subsequently trades heavy. The green boxes show the opposite, where the majority of issues are spending more time trending upwards than downwards. In these regimes, the dips get bought and the market trends higher.

And unless market breadth dramatically deteriorates in the coming weeks and months — which is possible considering the schizo macro environment we’re in — this measure of longer-term breadth is promising for those in the bull camp.

Here’s a short-term look at our breadth indicator for the Russell 3k. The higher this line is in the green, the stronger the underlying trend.

Notice that it’s still quite strong. This is one reason why this market is likely to become more overbought and overloved before a larger correction comes to wash out the weak hands that have built up.

The red vertical highlights show how this indicator weakens and rolls over before a larger selloff occurs.

When looking at market trend, I like to pull back and look at monthly or higher timeframes.

In the SPX, the 10yr+ bullish trendline remains intact. The long-term path of least resistance remains up. However, the market has now traded sideways for 30-months. This means it could either be in the process of putting in a cyclical top (though breadth and liquidity measures would argue that’s unlikely at this point) or it’s forming a large base to launch its next major bull leg higher.

A monthly close above the 3,300 level in the SPX would be needed to confirm the latter.

On a daily timeframe. The SPX is in a clear bull quiet regime where every good looking sell setup fails and every dip gets bought. The Feb 24th gap (red horizontal line) may be acting as an attractor.

So in totality, we have soft sentiment data giving neutral-to-bullish readings. Hard positioning data is more mixed. Put/calls are showing extreme complacency and hedge funds are back near record positioning in risk assets, while CoT and BofA Private Client data are still stuck in the mud.

Breadth is strong on both a long and short-term basis and isn’t showing any major signs of weakening, yet.

The long-term market trend remains up, though it needs to close above the 3,300 level to clear its current consolidation zone and confirm the start of a new bull trend.

The short-term tape is in a bull quiet regime, where the onus is on the market to signal a clear change in regime, from bull to bear. That hasn’t happened yet. The SPX looks like it may be forming another bull flag, similar to the one that formed in early May. In this case, we should expect some back and forth chop before the next leg up.

It’s likely that the Feb 24th gap in the SPX is acting as a price magnet. If the market were to quickly run-up to that level, it would suck in the last of the bears from the sidelines and then kick them in the shins by finally selling off to wash out the weak hands.

It’s a tough read, especially when we consider the tape-bomb risk, both negative and positive, inherent to COVID and fiscal/monetary policy at the moment (ie, when will the next CARES act be passed and will it be enough fiscal support? How bad will COVID get as economies reopen and how effective will the treatments we’re developing be? Etc…)

How you trade and invest in this very fluid environment should be determined by your particular approach, objectives, and risk preferences. However, what you should not do is engage in high conviction top calling or making any bold convictions whatsoever. This market will trample any who do.

There’s been a LOT of people on the sidelines of this recent bull move, whining about this or that and trying to call the top on every little daily blip. That’s not how you should play this game.

This is a much better environment to be a trader than an investor. A renter than an owner. And an oddsmaker than a predictor.

When it comes to trading macro, you cannot rely solely on fundamentals; you have to be a tape reader, which is something of a lost art form. ~ Paul Tudor Jones

Click Here To Watch My Webinar On Market Structure

Monday Dirty Dozen [CHART PACK]


History is hard to know, because of all the hired bullshit, but even without being sure of ‘history’ it seems entirely reasonable to think that every now and then the energy of a whole generation comes to a head in a long fine flash, for reasons that nobody really understands at the time—and which never explain, in retrospect, what actually happened… ~  Hunter S. Thompson

In this week’s Dirty Dozen [CHART PACK] we again look at the relationship between record money printing and stocks. We then talk about the technical overextension in tech and the deep relative value on offer in banks and energy stocks. We end with some charts on sentiment and show an analog of where we might be at today.

Let’s dive in.

***click charts to enlarge***

  1. I often talk about the important role of money (cash + credit) on the demand side in the supply and demand equation for financial assets. So we shouldn’t be under the illusion that it’s just some kind of coincidence that we just saw record money growth and the SPX’s best quarter of this century.


  1. Allen Sukholitsky, commented on the demand side of this causal relationship recently, writing “Short Case for Long Stocks. It’s not based on fundamentals (there aren’t many). It’s based on money (there’s plenty). The stock market rises an average of 31%, one year after a trough in S&P 500-to-money. The minimum return? +19%. One year after the ratio’s peak, the S&P 500 averages -12%. The maximum return? +2%. This past December and March appear to be a peak and trough, respectively… Relative to the economy, equities currently make little sense. But relative to money, equities make much sense.”


  1. According to NBER as well as BofA’s US Regime Indicator, the US is currently in a “Phase 4” technical recession.


  1. BofA shared the following tables showing which styles perform best at various phases of the indicator. And also the relative performance of value versus the SPX near recessions. If we are in Phase 4 and presumably moving into Phase 1 next, then value stocks might be a good area to start focusing your energies on.


  1. The opposite case can be made for high growth names such as those that dominate the Nasdaq. This BBG chart shows that the tech index is over 15% above its 200-day moving average (purple line). The tape is quite stretched and we shouldn’t be surprised if we see some mean reversion in the coming weeks.


  1. Speaking of value, US bank stocks are near their lowest levels ever on a relative basis against the SPX index.


  1. Oil and gas stocks are another area where we are seeing a lot of great deals (if you know where to look). Goldman Sachs commented on the improving supply and demand fundamentals for the sector in a note recently, writing: “Is 2020 just a pause in non-OPEC oil production growth? No, we believe we have come to the end of the delivery cycle of the 2010-14 mega-projects and non-OPEC structurally stops growing in 2021, as it did in 1988, eight years after the end of the previous capex cycle. This opens a new phase of structural OPEC market share gains, similar to 1988-2000.

“Is the under-investment in oil & gas cyclical or structural? We believe the under-investment is structural, driven by rising shareholder pressure on climate change (approval rate of climate-change shareholder proposals has tripled since 2011), driving hurdle rates for new oil projects to 20%, up from 10% in 2013-14. US shale shows a stronger element of cyclicality, driven by its short-cycle nature.”


  1. Here’s a new way of looking at AAII sentiment that I hadn’t come across before. BofA calls it “Farrell Sentiment”, which I assume is named after the legendary market technician, Bob Farrell — here’s Bob’s “10 Rules” if you’ve never read them before. The indicator is constructed by taking the 10-week moving average of AAII Bulls divided by the sum of AAII Bears and 0.5 times AAII Neutral.

Currently, it shows that investors are very bearish.


  1. But…. they’re becoming less so. If only by very tiny increments. BofA’s Bull & Bear indicator lifted off of zero last week for the first time in a looong time. Though, it’s still showing extreme bearishness and giving a buy signal.


  1. Also, BofA’s Private Client Sentiment Indicator, which measures ETF positioning in “EM/DM, Value/Growth, Small/Large, Cyclicals/Defensives, Stocks/Bonds + cash levels”, is also showing what can only be considered as extreme bearishness.

A lot of people have been pointing to the Robinhood traders getting active in the market for the first time, as a sign to be bearish since they are the penultimate “Dumb Money”. I have a different take… I think everyone is the dumb money and the time to worry is not when a bunch of Robinhooders are getting bulled up but rather when the suits and ties on CNBC and their money manager guests are seeing nothing but blue skies ahead.


  1. Here’s another way of looking at the fear in the market. This chart from BofA shows the 10-week moving average for the 3-month VIX curve. BofA comments on the chart, saying the curve “is coming off a big contrarian bullish oversold level similar to late 2008 and early 2002, which we view as a positive backdrop for US equities.”


  1. I’m personally not big into analogs but I thought this chart from @TimmerFidelity was too interesting to not share.

Stay safe out there and keep your head on a swivel.

Cash Flow: It’s All That Matters


Warning, this piece gets into the weeds of financial accounting statements. We dive deep into the cash flow statement, why it matters, and equip you with the knowledge to dissect statements on your own.

Before diving into the meat, one should understand why the cash flow statement is so important. There’s a few reasons:

    • You can’t easily fraud cash
    • Cash tells you the true earnings power of the business
    • You can’t pay debtors and creditors with EBITDA — you pay them with cash
    • Cash flow statements show you where a company generates cash and how it spends it over the course of a year or quarter

We’re using Cash Flow Analysis: Modified UCA Cash Flow Format to analyze the cash flow statement. I encourage you to download the PDF and follow along as you read this essay.

It’s What You Do With Cash That Matters

We study the cash flow statement because there are only a few ways companies can spend cash.

They can either buyback stock, issue dividends, acquire a business, reinvest in their own business or pay down debt. That’s about it.

Knowing how each of these decisions impacts a company’s cash balance is a crucial step in becoming a better investment analyst.

Let’s dive into the set-up for our cash flow analysis.

The Set-Up

The paper gives five case studies for analyzing cash flow statements. What’s interesting is that cases 1-4 report identical net income. How they get there is anything but identical.

We finish with a fifth example showing a net income loss. Through this fifth example we’ll see the power of focusing on the cash flow statement. It’s at this moment we see the detriment of obsessing over the P&L statement.

The First Four Cases

Our first four cases (or companies) generated $8M in revenue and $770K in net income. Those are the constants.

Let’s take a look at the first three cases’ income statement data:

C1-3 generated $1.12M in operating income and $1.02M in pre-tax income. Subtract out tax and we get our $770K net income figure.

Here’s where things get interesting. Though C4’s revenues are equal to C1-3 ($8M), C4’s operating income is almost $1M lower. How is this possible?

Take a look at C4’s income statement data:

There’s one line item that accounts for the discrepancy. C1-3 generated $140K from “Other Income” while C4 generated $1.1M. In fact, C4’s “Other Income” is enough to bring it in line with C1-3’s pre-tax income of $1.02M. That’s quite the difference.

The Power of Working Up The Income Statement

This is where we see our first large dichotomy on the income statement: Interest Expense & Other Income

Case 4 shows $770K in net income largely due to the $1.1M in “Other Income”. This is important. If you don’t actively analyze the income statement, you’d easily miss this.

If we “normalize” the “Other Income” for both companies, Case 4 would report substantially lower net income. In fact, if we normalize C4’s “Other Income” with C1-3, they’d report negative net income.

Now why does this matter? It matters because not all income is created equal. C1-3 are much stronger businesses because they generate the majority of their pre-tax income through their operations. You can’t say the same for C4.

In other words, you can’t rely on $1.1M in “Other Income” each year to make your bottom line. That figure could flip negative in an instant. Operating income on the other hand is much harder to sway. At least in that short of time frame.

That’s the 30,000ft view. Let’s dive into each specific case and look at their cash flow statements. What are they telling us that we can’t find on the income statement?

Company 1: Cash Flow vs. Income Statement Analysis

The first thing to focus on when moving from income statement to cash flow is accounts receivables. Specifically, you want to measure the change in those receivables.

In C1, we see -$500K in change in receivables. This means C1 sold more products on credit than they collected from customers that owed them money. In short, they received less cash in the bank from the product/service sold.

We adjust the change in receivables and recognize $7.5M in revenue. This is slightly lower than what’s reported on the income statement.

We see further differences in cost of goods sold (COGS). On the cash flow statement we see total COGS of $4.26M. This is lower than the income statement’s $4.96M.

The difference lies in an exclusion of an $800K deposit, as well as $300K increase in inventory reduced against $200K in paid accounts payable. This gives us $3.24M in gross profit (or 40.5% gross margins).

Operating expenses stay the same between the two statements at $1.92M.

Here’s the final core operating cash flow picture:

    • Income Statement: $1.12M
    • Cash Flow Statement: $1.32M

We’re going to use that $1.32M number on the cash flow statement to get true free cash flow.

After arriving at our core operating cash flow, we need to find how much cash to outlay for taxes. The cash flow statement shows $18K in recurring cash payments, plus $250K tax provisions.

We add $40K for deferred tax liability and -$42K for income taxes payable. This nets out to $252K needed for taxes. Those two figures ($18K and $252K) reduce our cash available (I.e., free cash flow) by $270K. This leaves us with $1.05M to service debt.

C1’s interest expense is $240K, which doesn’t deviate from income statement or cash flow statement. Now we’re left with $810K.

But we’re not done. We still need to account for capital expenditures. These can be for growth, maintenance, or a combination of the two. Regardless, we must pay them with cash.

Important Note: You won’t find capital expenditures in the income statement. You will only find that on the cash flow statement or balance sheet (potentially).

We see C1 spent $1M on CapEx in the current year. This brings our true FCF to -$190K.

The ending difference between what the income statement shows in net income vs. what the cash flow statement revealed as FCF:

    • Income Statement Net Income: $770K
    • Cash Flow Statement Free Cash Flow: -$190K
    • Total Difference: $960K

Onto Company 2!

Company 2: Same Income Statement, Different Cash Flow Statement

Remember, with C1-3 we have Identical Income statements. It’s the cash flows that differ.

C2 recognized $8M in revenue, but received $1.8M less in cash from that revenue. In other words, they sold $1.8M more product on credit than they collected from their customers. This could signal further problems with the business.

Questions to consider when faced with rising accounts receivables:

    • Why aren’t their customers paying?
    • Why are they selling more on credit?
    • Will they get those receivables back?

This gives us $6.2M in cash from revenues. Already off to a sketchy start.

It gets worse for C2. The company spent $4.76M in cost of revenue. C2 spent $1.2M on increasing inventory and saved $600K in accounts payable (I.e., not paying accounts payable for the period). They’ll eventually have to pay that $600K. So although it’s a positive adjustment to the current cash flow figure, we’ll need to reduce it by $600K at some point in time.

Adjusting for cost in revenues and changes in inventory/accounts payable gets us $1.44M in gross profit (18% margins).

You can see the effects these negative changes have on gross margins. Remember, Cases 1 & 2 have identical income statements, but C2 has 22% lower real gross margins.

From our gross margin we subtract operating expenses of $1.92M. This gives us core operating cash flow of -$480K. This is a much different picture than the income statement’s $1.02M pre-tax operating income.

Moving down the cash flow statement we see C2 with identical tax and liability payments ($252K). This brings cash available for debt service to -$750K. Bondholders won’t be happy about that.

Subtract another $240K in interest payments, another $1M in Capex and we get true free cash flow of -$1.99M. Ouch!

The ending difference between what the income statement shows in net income vs. what the cash flow statement revealed as FCF:

    • Income Statement: $770K in net income
    • Cash Flow Statement: -$1.99M in free cash flow
    • Total Difference: $2.76M

Not all hope is lost. Our third company proves a bit more promising for our bondholing friends.

Company 3: A Less Worse Picture of FCF

C3 looks better than both C1 and C2. The company generated $8M in revenue with a -$500K adjustment in receivables. This means C3 collected $7.5M in cash from those revenues.

C3 spent $4.26M to generate that revenue. $300K was spent on increased inventory, and $200K was saved by not paying accounts payable.

This gives us $3.24M in cash gross profit (40.5% margin).

Reducing our gross profit by $1.92M in operating expenses gets us $1.32M in core operating cash flow. This is $200K more than what’s stated on the income statement.

So far so good, right? Let’s move to the tax provisions and tax liabilities section.

C3 allotted identical amounts for tax provision, $250K. But this is where things get tricky.

C3 marked a $950K decrease In deferred tax liability. Confused as to what that means, check out the definition of deferred tax liability (according to Investopedia):

Deferred tax liability is a tax that is assessed or is due for the current period but has not yet been paid. The deferral comes from the difference in timing between when the tax is accrued and when the tax is paid.

The decrease means Company 3 paid more in taxes this year to make up for past taxes they didn’t pay. This is why you see C3’s total “Income Taxes Paid” at $1.242M.

After that massive tax bill, the company has a mere $60K to pay its debtors. Shave off another $240K in interest payments and we’re left with -$180K in operating cash flow.

Finally, the company didn’t spend any money on Capex in the current year. Maybe they didn’t spend anything for growth or maintenance. Regardless, C3 reported -$180K in true free cash flow.

The ending difference between what the income statement shows in net income vs. what the cash flow statement revealed as FCF:

    • Income Statement: $770K Net Income
    • Cash Flow Statement: -$180K Free Cash Flow
    • Total Difference: -$950K

Alright, at this point you’re probably wondering if we ever get to a company that shows positive free cash flow. Yes. Company 4 is our cash-flow knight in shining armour.

Company 4: What Positive Free Cash Flow Looks Like

We finally see positive free cash flow from C4’s cash flow statement. You know what we have to do. Break it down.

C4 generated $8M in revenues and $7.5M after adjusting changes in receivables.

C4’s cash cost of revenue came in at $4.9M. This breaks down to $4.8M from cost of revenues, minus $100 net change in inventory and accounts payable.

This gives us $2.6M in gross profit (32.5% gross margins).

From here we deduct our cash operating expense of $2.24M to get $360K in core operating cash flow.

As you might’ve noticed — this is substantially lower than C1 and C3. You’re wondering, “but Brandon, how in the heck can C4 get to positive free cash flow with all those interest and tax payments further down the statement? The answer: Other.

Company 4 received $942K in Other Recurring Cash Receipts. On top of that, they paid $252K in income taxes.

This means they have $1.05M in cash available for debt service.

Notice how large a benefit the recurring cash receipts were to the company’s free cash flow.

Are those receipts truly recurring? If not, we should assume this is a one-time benefit and forecast accordingly.

Now all that’s left is to subtract interest and capex to get our free cash flow.

Company 4 paid $240K in interest and spent $0 on Capital Expenditures. This gave them $810K in true free cash flow.

The ending difference between what the income statement shows in net income vs. what the cash flow statement revealed as FCF:

    • Income Statement: $770K Net Income
    • Cash Flow Statement: $810K Free Cash Flow
    • Total Difference: +$40K

Company 5: One Last Example w/ Different Income Statement

Company 5 has a different income statement than C1-4. Let’s flesh it out before going to the cash flow statement.

C5 generated $8M in sales. COGS totaled $5.6M and SG&A totaled $2.24M. This gave C5 $160K in operating income.

After subtracting $240K in interest expense, C5’s left with -$80K in pre-tax income. Add back $20K in tax benefits and you get -$60K in net loss.

Okay, now on to the cash flow statement.

C5 generated $8M in top-line revenue, but also recorded a $500K increase in cash received from receivables. This means the company reduced its accounts receivables (on the balance sheet) — collecting more cash from its customers than the previous period.

This gives us $8.5M in total cash received from revenues.

From that, we subtract $4.7M in cash cost of revenues. This includes $4.8M in COGS, a $300K positive adjustment for reduction of inventory and a $200K charge for accounts payable.

We’re then left with $3.8M in gross profit (47.5% gross margin).

Then we subtract our cash operating expenses ($2.24M) to get $1.56M in core operating cash flow.

So far, C5 has generated more core operating cash flow than C1-4. Let’s move down the statement for taxes and capex.

C5 paid $0 in income tax. How is this possible? The company had $20K in tax provisions offset by a $20K decrease in income taxes payable.

This left them with $1.56M in cash available for debtors.

After subtracting $240K in interest we’re left with $1.32M in operating cash flow.

C5 also elected not to spend any cash on capital expenditures, leaving all $1.32M for true free cash flow.

Operating Cushions, Working Capital and Core Growth Profile

As investors, we should focus more on the cash flow statement and less on the income statement. By going through each case study, we saw the differences a cash flow approach can make on analyzing a business’ true cash-generating capabilities. Each company generated the same amount of net income, but the amount of cash generated varied widely — and we could only pick that up by looking at the cash flow statement.

Our goal is to find companies that can grow the amount of cash they generate over time, and then to buy that company at a discount to those estimated cash flows.

But how can we estimate if a growing business is actually good for a company’s cash flows? After all, growth isn’t created equal. Growth can reduce cash flow in some companies, while juicing it in others.

That’s where Operating Cushion comes in. Simply put, Operating Cushion is the % difference between your gross margin % and your SG&A %. In English, it’s the contribution of a $1 increase in revenues to operating profits.

Using the paper’s hypothetical company, we see a gross margin of 39.56% and SG&A of 30%. This gives us 9.56% in operating cushion.

So, a $1 increase in this company’s revenues generates $0.096 in operating income.

The higher the better.

The paper takes it one step further, calculating a company’s Core Operating Growth Profile.

This is simply your Operating Cushion plus Working Capital %.

Here’s how we get Working Capital %:

    • Subtract A/R to revenue %
    • Subtract Inventory to revenue %
    • Add A/P to revenue %

In the example from the paper, this gets us -36.48% in working capital and -26.92% in Core Operating Growth Profile.

So, for every $1 increase in revenue, the company will burn $0.26 in operating cash flow.

You can see how powerful Operating Cushion and Core Operating Growth Profile is to an investor’s toolkit.

Closing Thoughts

The cash flow statement is the most important financial statement in a company’s books. It shows us how much cash a business generates, where management spends the cash, and how much they actually receive on their revenues.

It shows us a company’s cash-generating power, not its financial engineering pedigree.

By focusing on the cash flow statement, we’re also able to determine if growth is value creative or destructive.

If this white-paper has taught me anything, it’s that cash flow is king. Focusing on cash flow (not the income statement) will make you a better investor.

Monday Dirty Dozen [CHART PACK]


Being a great trader is a process. It’s a race with no finish line. The markets are not static. No single style or approach can provide superior results over long periods of time. To continue to outperform, the great traders continue to learn and adapt.  ~  Jack Schwager

In this week’s Dirty Dozen [CHART PACK] we look at more signs of STRONG BREADTH, then we take a gander at improving economic surprises and what they may mean. We follow that up with some talk about small-caps and materials outperformance, cover the deep value on offer in Europe, and end with an energy name that has a nice looking tape.

Let’s dive in.

***click charts to enlarge***

  1. Citi’s Economic Surprise Indices (CESI) have been turning up and rebounding from incredibly depressed levels. It’s now positive for the US and APAC region with Europe being the laggard.


  1. Economic prints positively surprising to the upside is typically a bearish bond development. Hence why bonds broke to the downside from their consolidation pattern last week. The chart below shows the strong correlation between the two. The yellow line is the CESI and the blue line is the QoQ% performance of the UST 10yr yield. We could see yields pop here…


  1. Rising yields and a steepening curve typically coincide with outperformance from small caps and value. Which is what we’ve started to see over the last two weeks. This NDR chart shows there’s a lot of mean reversion left to unwind for small-caps. The Russell 2000/1000 hit its most oversold levels on a YoY% basis since July 1999 (chart via @edclissold).


  1. Bear market bottoms have occurred an average of 4-months before recession end dates. This chart from NDR shows small-cap relative to large-cap performance coming out of recessions (chart via @edclissold).


  1. NDR’s model now favors small-caps over large by the most in over 22 months (chart via @edclissold.)


  1. Mark Minervini, shared another NDR (I know, I’m sharing a LOT of NDR charts this week!) chart showing more evidence of strong breadth thrusts — as I pointed out last week as well. Mark tweeted “NYSE momentum thrust just gave a buy signal yesterday with advancing stocks leading declining stocks by better than 2 to 1 over the last 10 trading sessions. This gives us a good indication that pullbacks in the S&P 500 should be viewed as buyable.” I agree…

  1. And one last NDR Breadth Thrust chart, I promise. This one shows NDR’s Multi-Cap Equity Series % of stocks above their 10-day moving averages. The arrows on the chart mark past instances when this thrust has triggered. It’s got a pretty good bullish record. 


  1. Improving liquidity, strong breadth thrusts, and improving econ data typically leads to outperformance from cyclicals. Renaissance Macro Research shared this on the twitters last week and wrote “Materials, as an industry group, historically respond well to relative FCF/EV.  Don’t look now, but it’s at levels last seen in early 2000 just as China’s voracious appetite for commodities exploded.  Now we just need some improvement in relative performance (ex gold names)”.


  1. I pointed out the other week in these pages how some European indices have the best looking charts at the moment. Well, it just so happens that European value stocks are about as cheap as they’ve ever been right now relative to growth names.


  1. @MacroCharts published a good post last week pointing out the growing signs of complacency in the options market. You can read it here. Here’s a chart from the post showing the extreme levels of relative volume we’re seeing in the Nasdaq.


  1. Just so this post isn’t too one-sided on the bull front. This table from @LeutholdGroup offers the counterpoint. They write “Is this the first leg of a new bull market or 2nd-largest bear rally of 125 yrs? The March low was 0-for-5 w/ conditions typical at cyclical bear lows. And the 30% surge off the low met 0-of-3 dynamics that usually accompany the 1st leg of a bull market. 0-for-8 is not encouraging.”



  1. There’s some good looking price action in energy names right now. If the global economy is indeed recovering then we’re going to see the oil market tighten significantly later this year. I like a lot of names in this space. One of my favorites is the E&P Vaalco Energy (EGY).

Stay safe out there and keep your head on a swivel.

Monday Dirty Dozen [CHART PACK]


The beginner plunges ahead on a favorite that loses, then bets lightly on a fair-priced horse that wins. He keeps switching amounts and positions, so that he never has a worthwhile bet on a winner at a worthwhile price. He is always one race behind the form of a horse and several races behind the rhythm of the results sequences.  ~  Robert L. Bacon

In this week’s Dirty Dozen [CHART PACK] we look at the STRONG BREADTH we’re seeing in markets around the world, then dive into the potential source of that breadth, before covering some dirt-cheap international markets with exceptional long-term chart setups, and finally end with some precious metals, demographics, and short-term signs of complacency…

Let’s dive in.

***click charts to enlarge***

  1. Something happened last week that hasn’t happened in 29 years. 96 percent of S&P 500 stocks were above their 50-day moving average… That’s after hitting near-record lows in March. The last time breadth hit similar levels was in early 91’ following the 90’-91’ bear market and recession, which then preceded the great 90s bull market.


  1. The following chart from NDR shows past instances (marked by arrows) where this short-term breadth indicator crossed above 90 after falling to at least 75% in between. Out of the 19 cases, the market was up a year later each time with a median return of 16.28% (chart via @edclissold).


  1. And here’s the return following each thrust 2-months later (chart via @edclissold).


  1. The strong breadth isn’t unique to just the US either. Here’s the same NDR chart but for the MSCI Europe Index where 92% of stocks crossed above their 50-day moving average last week, for the first time in over three years (chart @WillieDelwiche).


  1. The Dark Index (DIX), a measure of off-exchange transactions (you can find more information here) hit 52.3% on Friday. That’s the highest number on record. @SqueezeMetrics, the creator of the DIX, points out that “off-exchange transactions have been ‘overwhelmingly’ bullish since late March”.


  1. The strong demand for risk assets that we’re seeing is making many financial twitter warriors and newsletter writers head’s spin, as they see a total disconnect between the market and the economy. What they don’t get is that the market operates off its own fundamentals and it recently saw a huge boost to the demand side of that equation. Ben Carlson shared in a recent blog post (link here) how “the major brokerages — Robinhood, Charles Schwab, TD Ameritrade and Etrade — saw new accounts grow as much as 170% during the first quarter” and that one of the biggest beneficiaries of the stimulus checks was securities trading.


  1. People email me all the time asking me if I’m bullish or bearish right now. I don’t have a single answer for that question (it depends on the timeframe) and even then, my opinions are very weakly held, especially now. I’m just trying to play the tape in front of me and let the market tell me what’s what.

With that said, there’s some great looking charts in emerging markets and Europe that need to be on your radar. Malaysia (EWM) is one of these. It’s selling on the cheap… there are also a number of long-term fundamental reasons to be bullish on the country — not to mention the monthly price action is 👌.


  1. Poland (EPOL) is another. Na Zdrowie!


  1. EURUSD has tried to break down only to reverse four months in a row now. This last month saw a strong close. The market is rejecting lower levels which raises the odds of higher ones. It’s still in a sideways regime and we need to wait for a breakout but pay attention. A weaker dollar (stronger euro) would fit with a lot of the other price action I’m seeing across markets right now.


  1. Precious metals continue to run strong (I last updated the bull case here). Silver especially has been putting in some work on closing the gold/silver performance gap I pointed out a few weeks back. It saw a strong close for the month. Look for higher prices and a break above its long-term base soon.


  1. Ensemble Captial published a piece recently on where they think the “Next Normal” will be, following the impact of the virus, that’s worth a read (link here).

“Obvious: Coronavirus is going to increase the global death rate.

“Less Obvious: Coronavirus is going to increase the global birth rate.

“Historically, baby booms occur for a combination of cultural and biologically programmed reasons. In the aftermath of a tragic experience such as this pandemic, it’s natural for people to reconsider their goals, priorities, and changing circumstances. One of the important things that come out of an event like this, where people are stuck at home or dealing with potentially grave illness, is the realization of the importance of family, companionship, or simply boredom avoidance. Combined with the ability to move further away from urban areas and increasing affordability in the suburbs, it may well be that we see baby booms around the world. In the US, that may stabilize or reverse the trends of lower than replacement procreation (2019 SAW ONLY A 1.7 FERTILITY RATE, below the 2.1 needed to sustain a population ex immigration).”


  1. While the strong breadth is certainly a bullish development the stretched put/call ratios are an indication of complacency and a source of short-term fragility as @MacroCharts pointed out last week.

Stay safe out there and keep your head on a swivel.

Two Free Breakout Alerts For The Week Ahead


Once a month we’ll feature a breakout (or two) from our premium Breakout Alerts service. This service is for members only and highlights half-a-dozen potential breakouts each week! We’ve had decent success this year with the service and returned nearly 20% in Q1.

This article features two new breakout alerts that will go out to our premium members over the weekend.

Let’s dive in!

Breakout #1: Wedge Industries (000534)

Business Description: Wedge Industrial Co., Ltd. invests in, develops, sells, and operates real estate properties in China. It also engages in power generation and steam heat supply activities.

The company was formerly known as Guangdong Wanze Industrial Co., Ltd. and changed its name to Wedge Industrial Co., Ltd. in May 2013. The company was founded in 1992 and is based in Shantou, China. –


    • Market Cap: $622M
    • Enterprise Value: $675M
    • EV/EBIT: 36x
    • ROC: 2.90%
    • 3YR Avg. FCF: -$30M

What We Like:

    • Reduction in share count
    • Pays a dividend
    • EBIT covers interest expense 1.50x

What We Don’t Like:

    • Burning cash
    • Lots of debt
    • No room for error in lower earnings on debt payments (could slip into failing covenants)

Chart Analysis:

Short Trade Parameters:

    • 3% Entry: $8.32
    • 1.50% Entry: $8.45
    • Stop-Loss: $8.92
    • Profit Target: $6.95
    • Reward/Risk: 3.20x

Breakout #2: Xilinx, Inc. (XLNX)

Business Description: Xilinx, Inc. designs and develops programmable devices and associated technologies worldwide. The company offers integrated circuits (ICs) in the form of programmable logic devices (PLDs), such as programmable system on chips, and three dimensional ICs; adaptive compute acceleration platform; software design tools to program the PLDs; software development environments and embedded platforms; targeted reference designs; printed circuit boards; and intellectual property (IP) core licenses covering Ethernet, memory controllers, Interlaken, and peripheral component interconnect express interfaces, as well as domain-specific IP in the areas of embedded, digital signal processing and connectivity, and market-specific IP cores. –


    • Market Cap: $22.13B
    • Enterprise Value: $21.17B
    • P/Normalized E: 33.19x
    • EV/EBIT: 30x
    • FCF Margin: 28.6%

What We Like:

    • FCF positive 10 straight years
    • 60%+ Gross Margins
    • 25% Operating Income Margins
    • Decreasing Share Count
    • Net Cash

What We Don’t Like:

    • Cyclical industry
    • Loads of competition
    • Increase cash conversion
    • Increase Days Inventory

Chart Analysis:

Long Trade Parameters:

    • 3% Entry: $95.05
    • 1.50% Entry: $93.66
    • Stop-Loss: $85.37
    • Profit Target: $117.78
    • Reward/Risk: 2.91x

That does it for this week’s featured breakouts. If you’re interested in learning more about our premium service, drop us an email or comment down below. We’d love to chat with you!