In uncertain financial times, it's always good to have some actual cash in your pocket - and the next best thing is to have some "cash cows" in your portfolio.
We're not talking commodities here. Rather, we mean cash-rich companies with plenty of "moo-lah" to reinvest in their own growth, or in share buybacks or increased dividends for stockholders.
The expression "cash cow" means just what it sounds like: Something that, once acquired and paid off, can produce consistent cash flow over its lifespan.
As an example, imagine a company with a pool of more than $1 billion in cash on hand. If it does nothing more than invest that $1 billion in an interest-bearing account paying 4.5% a year, it can generate enough interest income to pay 1,000 workers $45,000 per year - year after year after year - without depleting its original cash balance.
That's the perfect definition of a true cash cow.
Six months after the September 2008 market meltdown, Morgan Stanley (NYSE: MS) reported more than $150 billion invested in cash or cash-equivalents, such as three-month Treasury bills - even though they were then yielding a puny 0.09%. That was almost a quarter of its balance sheet, and twice as much cash as it had just a year earlier.
Other corporate giants like American Express Co. (NYSE: AXP), The Coca-Cola Co. (NYSE: KO), Goldman Sachs Group, Inc. (NYSE: GS), 3M Co. (NYSE: MMM) and Merck & Co. (NYSE: MRK) also reported sharp increases in their holdings of cash and easy-to-sell securities in the first quarter of 2009 - liquidity that helped continue growth and maintain profits while many others struggled.
"Although this creates a noticeable drag to our earnings," Morgan Stanley finance chief Colm Kelleher noted at the time, "we believe that maintaining a strong liquidity position is currently the most prudent approach."
Cash-cow companies can reinvest in new systems and plants, pay for acquisitions and support themselves when the economy slows. They have the capacity to pay down existing debt, increase their stock dividends or reinvest the cash to further boost returns - all without sacrificing profitability. And smaller cash cows also can prove to be tempting takeover targets.
However a cash-rich company opts to use its surplus, shareholders stand to benefit. So, obviously, the question for investors becomes, "How can I grab a piece of the action?"
Finding a company that generates gobs of green sounds exciting on the surface, but that alone isn't enough to make for a solid investment. However, if the stock provides other solid incentives - such as a high return on equity (ROE) and a strong return on assets (ROA), while still trading at a good price - then it's definitely worth investigating.
So, where should you look for cash cows?
Simply put, you're most likely to find them among:
The reasons behind these broad guidelines are simple. First, more mature companies, while they have less room for growth, often generate more free cash flow than newer ones because the initial capital outlays required to establish and grow their businesses have already been made.
Second, money managers increasingly prefer using free cash flow over earnings as an indicator of a company's true health because the calculation is less susceptible to the many discretionary accounting adjustments that can inflate net income.
Third, a high market share and brand-name dominance impede growth by competitors, translating into recurring revenues, high profit margins, and healthy and ongoing cash flow.
Drug companies that have spent decades developing proprietary products with long patent life are a good example. Take Amgen, Inc. (Nasdaq: AMGN), a pioneer in biotechnology manufacturing, which won a 2007 patent-infringement lawsuit that preserved its $7 billion anemia drug franchise. From 2005 to 2009, Amgen's earning per share (EPS) increased from $3.20 to $4.91. First-quarter 2010 financials posted April 21 showed earnings of $1.24 per share on revenues of $3.65 billion.
Most interesting, Amgen in 2009 increased its cash and short-term investments to $13.442 billion, roughly $13.83 per share, or one-third of the company's total assets. That's up from one quarter in 2008 and one-fifth in 2007. Free cash flow at the end of 2009 rose to $5.763 billion, or $5.93 per share.
There are any number of ways to assess a particular stock's potential as a cash cow, but using some of the following criteria can help you narrow the field:
Most of the above numbers and valuations - or the figures needed to calculate them - can be found on the company balance sheets or the statistical sections of the "stock quotes" summaries on key financial websites such as MSN Money, Yahoo Finance or Forbes.com.
Here are seven stocks you can look at as you begin your search for cash cows. Thanks to price increases generated by the market's persistent rally in recent months, not all of them fulfill each of the criteria listed above (most notably exceeding the suggested price-to-free-cash-flow ratio), but all are close - and well worth watching.
Protective Life Corp. (NYSE: PL), recent price $24.15 - This regional life insurance and investment company had estimated year-end 2009 free cash flow of $1.144 billion, or $13.34 a share, providing a free-cash-flow yield of 55.2% and a price-to-free-cash-flow ratio of 1.81. Earnings per share were $3.34, the company had $49 worth of cash on hand per share, a dividend yield of 2.0% and a debt-to-equity ratio of 0.59.
Bank of America Corp. (NYSE: BAC), recent price $18.61 - Despite some much-publicized concerns and a sharp dividend cut in 2009, this banking giant continues to demonstrate cash-cow characteristics. At year-end 2009, BAC had an estimated free cash flow of $156.37 billion, or $15.59 per share, providing a free-cash-flow yield of 83.8%, with $52 per share in cash on hand. On the negative side, the company posted a 2009 loss of 26 cents a share, cut its dividend to just 4 cents for a yield of 0.2% and listed a fairly high debt-to-equity ratio of 2.62.
Constellation Energy Group, Inc. (NYSE: CEG), recent price $37.09 - This Baltimore-based supplier of energy products and services covers the United States, with a focus on the East Coast. At the end of 2009, it had an estimated free cash flow of $6.135 billion, or $30.37 a share, providing a free-cash-flow yield of 81.9% and a price-to-free-cash-flow ratio of 1.20. Earnings per share were $22.07, the company had just over $17 worth of cash on hand per share, a dividend yield of 2.6% and a debt-to-equity ratio of 0.55.
Barnes & Noble, Inc. (NYSE: BKS), recent price $22.33 - Though much of the publishing industry is beset by woes brought on by electronic media, this international bookseller continues to generate substantial cash. At year-end 2009, it had an estimated free cash flow of $414.7 million, or $7.15 a share, providing a free-cash-flow yield of 32% and a price-to-free-cash-flow ratio of 3.10. Earnings per share were $1.11, a dividend yield of 4.5% and a minuscule debt-to-equity ratio of 0.11. The only negative was that cash on hand was just 70 cents per share.
Whirlpool Corp. (NYSE: WHR), recent price $96.09 - This major home appliance maker had a free cash flow of $848.25 million, or $11.31 per share, at the end of 2009, providing a free-cash-flow yield of 11.77%. Earnings per share were $4.34, WHR had $18.45 a share in cash on hand, a dividend yield of 1.8% and a debt-to-equity ratio of 0.79.
PHH Corp. (NYSE: PHH), recent price $24.78 - Despite the well-publicized problems in the housing market, this New Jersey-based provider of mortgage and credit services continues to throw off plenty of cash. At year-end 2009, it had an estimated free cash flow of $1.277 billion, or $23.22 a share, providing a free-cash-flow yield of 93.7% and a price-to-free-cash-flow ratio of just 1.10. Earnings per share were $2.75 and it had cash on hand of $2.72 a share. Minuses include the lack of a dividend and a fairly high debt-to-equity ratio of 3.46.
Zions Bancorporation (Nasdaq: ZION), recent price $27.42 - Like Bank of America, this Utah-based regional bank showed an operating loss for 2009, but its cash-flow numbers remained healthy. With an estimated $1.714 billion in free cash flow, or $10.85 a share, ZION had a free-cash-flow yield of 39.6% and a price-to-free-cash-flow ratio of 2.70. The loss per share was $3.59 and it had cash on hand of $8.67 a share. The only negative besides the loss is a tiny dividend yield of 0.1%.
News and Related Story Links: