SAN FRANCISCO (MarketWatch) — Having picked stocks for 48 years, Bob Olstein has seen his share of bull and bear markets.

In this current quarterly earnings season — just like every other — Olstein sees himself surrounded by short-term traders who show little regard for a company’s long-term fundamentals. To him, it’s created a disconnect between stock prices and companies’ free cash flows.

Olstein, manager of Olstein All Cap Value Fund OFAFX, -1.02% , is an accounting-driven value investor fond of cash flows. Free cash flow isn’t a term you’ll come across too often — or at all — from an expert talking up a stock on TV or in a research report from a big Wall Street brokerage. Read more: Olstein: Investors turned traders give up their edge.

Olstein: Quality of earnings is key

Free cash flow is the lifeblood of a company. It’s the money left at the end of each quarter after all the expenses and stockholder dividends are paid. It’s cash that can be used to invest in new products, increase the dividend, pay off debt or acquire a rival.

To determine if a stock is a buy, MarketWatch asked Olstein and other value-minded managers what key go-to measures they use when diving into a company’s finances. Read more: How to know if a company is seasoning its earnings.

These balance-sheet detectives provided current investments that fit some of that criteria. Read more: How short-selling sleuths spot accounting tricks.

Harman International Industries

Olstein bought Harman International Industries Inc. HAR, -2.38% at $30 a share in September 2009, following a restructuring at the maker of auto electronics and stereo systems. The stock recently traded near $46.

Olstein said he believes the shares are worth $75 based on his projections for free cash flow per share to grow 10% to 15% a year through 2015.

If he’s right, that would put Harman’s free cash flow per share at around $4.

Harman is the largest holding in the Olstein All Cap Value Fund. Olstein said he’s comforted by Harman’s $14 billion contract backlog, growing use of electronics in cars, and improving margins. Inside a car, Harman makes brands such as JBL and Infinity that control GPS, voice-activated telephone systems, wireless Internet and entertainment systems.

“That’s all Harman on the front dashboard,” Olstein said.

Microsoft

Value investors like to buy companies that ooze free cash flow when their stock prices are beaten down — often by bad news that scares everyone else off or by general skepticism in a company’s direction.

Larry Pitkowsky, who co-manages GoodHaven Fund with Keith Trauner, said he aggressively bought Microsoft when its stock traded in the mid-$20s last spring and summer.

At the time, the shares were trading around their 52-week low.

Free cash flow was one reason GoodHaven’s managers liked the stock. For its June 2011 fiscal year, Microsoft Corp. MSFT, -1.04% generated $19.5 billion in free cash flow, a figure that’s grown from $9.2 billion in 2006.

When he buys a stock, Pitkowsky makes sure a company can pay off its debt without running into a major hitch, such as having to refinance a significant portion of that debt at a higher cost in an economic storm.

That shouldn’t be a problem for Microsoft. Long-term debt is $11.9 billion. Currently, that’s less than the cash Microsoft’s business is producing after all the expenses are paid, including its dividend.

For years, investors have viewed Microsoft as an investment has-been that lost its technology leadership to Apple, Google and Facebook.

To Pitkowsky, Microsoft shares seemed like a safe and cheap bet based on another metric he employs: free cash flow per share as compared to stock price.

When free cash flow per share is rising and a company’s stock is beaten down (that was the case with Microsoft in the summer of 2011), this can indicate a stock is set to gain because high free flow per share can foreshadow stronger earnings in the future.

“We felt comfortable that the earnings were not declining anytime soon,” Pitkowsky said. “We feel intrinsic value is north of $40 a share.”

Microsoft is one of Goodhaven’s GOODX, -0.67% largest holdings. The fund, launched a year ago, has done well with the stock. Microsoft shares are up 24% over the past 12 months, and recently traded at around $31 a share. Read more: Microsoft shares gain after upbeat earnings results.

JPMorgan Chase and Wells Fargo

Return on equity, or ROE, is an important metric in deciding whether or not a stock is a buy, according to Timothy Vick, author of “How to Pick Stocks Like Warren Buffett.” He favors companies with strong and sustainable return on equity.

Are we supposed to trust earnings reports?

Vick measures a company’s return on equity against its book value to determine if a stock is underpriced. If a company trades for less than its book value but it’s return on equity should improve, it can signal better prospects for the stock price.

Vick, senior portfolio manager at Sanibel Captiva Trust, said stocks are mostly efficiently priced under this metric. It takes some guesswork since future returns on equity must be deduced.

“If a company has a ROE of 20%, and it’s trading at book value, returns to shareholders will average 20% if the company can sustain its ROE,” Vick explained.

Under this formula, he’s purchased shares of JPMorgan Chase & Co. JPM, -0.84% and Wells Fargo & Co. WFC, -2.35% .

J.P. Morgan was bought for between $31 and $32 a share back in December when the bank fetched 70% of its book value. Return on equity was 11%. Shares recently sold for about $43.

Vick said he was a buyer of Wells Fargo last fall when the shares traded in the mid $20s. The company now trades at about 130% of book value, at $33 a share. Vick figures return on equity can get to 14% from the current 12% level.

Cisco Systems

Cash flow to enterprise value is a standard metric that private equity firms use to determine the cash-on-cash return they’d get if they acquired a company using no debt to finance the deal.

To Vick, it further tells him the possible return on the stock if a company no longer grew profit or cash flows. He likes this ratio to be 10% or higher.

Cisco Systems Inc. CSCO, -0.17% fit the bill last August when its shares slid to a three-year low. That put the ratio at roughly 15%.

“Compared to a 2% long-term bond, it was a no-brainer,” Vick said. “We didn’t think there was much downside risk left.”

Cisco shares are up 47% from their 52-week low and closed Thursday at $19.92.

Two to avoid

Want to avoid losing money on a stock? Look for companies hard pressed to grow cash flow year after year, said Jeff Middleswart of Behind the Numbers, which issues sell recommendations to its hedge fund and mutual fund clients.

Goodyear Tire & Rubber GT, -1.29% is one laggard, he said.

In five of the past six years, Goodyear has reported negative free cash flow — even in the past two years with global car sales on an upswing.

These kinds of situations can put a company in a bind. “In 2011, higher raw material costs drove up working capital and Goodyear was forced to borrow money and issue preferred stock,” Middleswart said.

Goodyear’s stock is down 30% since April 2011. The stock traded near $40 a share in 2007. It now goes for just north of $11.

Restructuring charges are another item Middleswart eyes first. He looks for situations where a company has taken a charge four times over a six-year period and tracks how the company’s margin has progressed.

Avon Products AVP, -6.25% is one his firm has been sour on for a long time. The cosmetics seller recently rejected a hostile bid from smaller rival Coty valued at $10 billion.

Usually, the point of restructuring is to cut costs and boost margins. That hasn’t been the case for Avon: Net margin is 4.6%, down from 8.3% in 2008. This means that for every dollar Avon has earned, it’s made less profit.