As we patiently await an inevitable bounce in the price of crude oil, we still need to guard against further downside. While I don’t believe today’s crude price is sustainable, if OPEC decides to continue its present course we may dip a bit more over the next few months before prices start to recover.

So what’s an investor to do? If you are the patient, long-term type, I wouldn’t worry too much about short-term moves over the next few months. We’re much more likely to see oil at $60/bbl over the next three years than $40/bbl, so buying at today’s prices should prove a profitable long-term move. But I am no longer confident that the $40/bbl floor will hold in the short term. There is a realistic chance that crude drops into the 30s before recovering.

Where does that leave short-term investors, or anyone wishing to be positioned for a recovery while protecting against further declines?  I would primarily look to free cash flow (FCF) for guidance.

FCF is a measure of the amount of cash generated by a company that is available for reinvestment or distribution to shareholders. It is one of the best measures of a company’s overall financial health. Companies have been slashing capital expenditures over the past year, and those that have managed not to spend all of their cash flow should be among those best able to withstand several more months of low oil prices.

There are a number of different iterations of the FCF calculation, so it is important to define our terms. I pull levered FCF stats from the subscriber-only S&P Capital IQ database. The calculation begins with a company’s net income, adds back depreciation and amortization (because those non-cash costs relate to historical expenditures), adjusts for impairments to oil and gas properties (those non-cash impairments affect net income but not cash flow) and then subtracts interest paid, changes in working capital and capital expenditures:

FCF = Net income + Depreciation/Amortization + Impairments – Change in Working Capital – Capital Expenditure – Interest Costs

It’s important to understand how the impairments work, because they can be confusing. Future cash flows are estimated on the basis of prevailing oil and gas prices. If prices are low, a company may have to take some oil and gas reserves off the books because they wouldn’t be worth extracting at prevailing prices. This results in an impairment, and it lowers net income. However, this is merely a paper loss and it doesn’t reduce cash flow. Thus, in the FCF calculation, the impairment is added back to net income. I will provide an example below.

Before I discuss specific companies, I wanted to first give readers a behind the scenes look at the stock screening tool that I developed and have been refining this year. You have seen many of the tables generated from the data, but I want to give readers a deeper appreciation for some of the things this tool can do.

The tool is based on an Excel plugin for the S&P Capital IQ database. It can summon data on pretty much every publicly traded stock on any of the major exchanges worldwide, but of course I limit my screens to energy companies. Here is the screenshot of the tool as I used it to gather data for this article:

Note that the first column shows tickers from the Euronext exchange in Amsterdam (ENXTAM), the Stock Exchange of Hong Kong Limited (SEHK), the New York Stock Exchange, the Toronto Stock Exchange (TSX), the NASDAQ, the Oslo Stock Exchange (OB), and the Moscow Stock Exchange (MICEX) — to name just a few of the exchanges accessed by this screener.

While the number of publicly traded energy companies fluctuates on a weekly basis, on the date I ran this screen it pulled 45 columns of data (defined by me) on 1,561 publicly-traded companies in seven categories (e.g., Integrated Oil and Gas, Oil and Gas Drilling, etc.) Following the initial screen I removed some of the listings on minor exchanges from the results, as well as all companies with an enterprise value (EV) of less than $100 million. That left 587 stocks.

Such automated culling cannot replace a detailed analysis of a prospective investment’s operations and results. But it does provide useful comparisons and can help identify promising candidates for further research.

Here are the free cash flow leaders for the entire energy industry, based on the FCF generated in the most recent fiscal quarter (FQ).

• EV = Enterprise value in billions as of Nov. 24
• EBITDA = Earnings before interest, tax, depreciation and amortization for the trailing 12 months (TTM), in billions
• Debt/EBITDA = Net debt at the end of Q3 divided by TTM EBITDA
• FCF (FQ) = Levered free cash flow in Q3 in millions
• YTD = Year-to-date total return

Note that each of these companies had more than $1 billion of FCF in Q3, and all but two have had positive FCF for the past 12 months. Still, none of these stocks has a positive total return for the year.

Half of the names on the list above are integrated oil and gas companies. Delving within that category only, the top 10 looks like this:

Here is the top 10 in FCF for just the non-integrated oil and gas producers:

Note that the upstream partnerships in the group have gotten hit really hard by the combination of lower commodity prices and general bearishness in the MLP space.

This table also shows the impact of impairments. Take Linn Energy (NASDAQ: LINE), for example. Linn reported a net loss of $1.569 billion for the third quarter. How then did it have FCF of $1.8 billion? The net loss resulted from an impairment of $2.255 billion, which lowered Linn’s net income but had no impact on cash flow. While the free cash flow calculation involves several other inputs, this impairment accounted for the bulk of the difference between net income and FCF.

Here were the top 10 service providers by FCF:

Finally, the top 10 refiners and marketers:

Almost all of the refiners are up solidly year-to-date, and several have been portfolio recommendations for most of the year. As expected, the refiners have benefited tremendously from falling oil prices, and will continue to benefit as long as oil prices remain low. However, the higher oil prices we expect over the next few months should cut into refiners’ margins, and we believe the risk now outweighs reward as a result.

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