By Serkan Unal
In a 1982 letter to Berkshire Hathaway shareholders, Warren Buffett said he preferred investing in "businesses enjoying good returns on equity (ROE) while employing little or no debt." While liability positions of some of Buffett's current portfolio holdings are not necessarily consistent with that statement, companies with strong return on equity and little or no debt should appeal to prudent investors. Debt-free companies may be safer than heavily leveraged firms during periods of economic and financial stress or rising interest rates that increase the cost of capital. Moreover, debt-free companies with substantial cash and strong free cash flow generation have better and cheaper access to working capital and likely a greater flexibility than leveraged companies to undertake opportunistic investments.
Running a screen on the dividend-paying companies with yields at or above 2% and market capitalization above $2 billion, we have identified four companies that meet the aforementioned criteria. The four companies have zero or negligible long-term debt, ROE at or above 20%, and historical, current, and forward long-term EPS growth higher than 5%. Most of these companies also have a high proportion of cash relative to total assets. Here is a closer look at each of these four dividend stocks.
Accenture Plc (ACN), a global management consulting, IT services and outsourcing firm, has negligible long-term debt and boasts an ROE of 63%. Its current ratio is 1.51. The company also has a relatively high proportion of cash and equivalents to total assets that equals to almost 40%. It generates consistently high free cash flow, and its ratio of free cash flow to net income is 1.26. The company realized an average EPS growth of 14.3% annually over the past five years. Analysts forecast its long-term EPS CAGR at 10.2%. While the long-term outlook looks robust, it should be noted that the company may be facing a slowdown in outsourcing sales growth in the coming quarters, based on Morgan Stanley's proprietary model. Accenture has a dividend yield of 2.3% and five-year dividend growth of nearly 29% per year. Its dividend payout ratio is 45%. The company is priced at 17.5x trailing and 15.7x forward earnings. Its trailing P/E is above the industry's 22.7x, while its forward P/E is below the industry's 16.4x. Hedge fund Lansdowne Partners trimmed its position in ACN by 28% last quarter, but still held nearly $468 million in the stock.
Automatic Data Processing Inc. (ADP), a payroll processing and business outsourcing company, is another firm with negligible long-term debt and an ROE of 22.6%. Its current ratio is 1.07. The share of ADP's cash and equivalents in total assets stands at a relatively low 5%, but its other current assets category is high in proportion to total assets. The company generates consistent and sizable free cash flows equal to 0.91 times net income. ADP's EPS growth averaged 9.0% annually over the past five years and is expected to hover around that annual rate, on average, for the next five years. The company's growth is driven by pay-per-control growth and product innovation; however, its outlook for EPS expansion in 2013 of between 5.0% and 7.0% is below analyst expectations for a 9.3% gain. The analyst forecast for EPS growth is robust taking into consideration the persistently slow employment recovery. ADP pays a dividend yield of 2.9% on a payout of 55%. Its dividend growth averaged 10.7% per year over the past half-decade. ADP is somewhat pricey at 19.9x forward earnings, which puts it almost on par with major rival Paychex Inc. (PAYX). Last quarter, Jean Marie Eveillard's First Eagle Investment Management held more than $191 million in ADP.
C.H. Robinson Worldwide Inc. (CHRW), the world's largest third-party logistics provider, is another company that matches the aforementioned criteria on low debt and high ROE. CHRW has no long-term debt and boast an ROE of nearly 35%. Its current ratio is 1.84, while its ratio of cash and equivalents to total assets is about 17.5%. This freight transportation company has a free cash flow to net income ratio of 0.76. Its EPS growth averaged 11.4% per year over the past five years and is expected to accelerate to 12.3% per year for the next five years. Greater outsourcing of logistics needs and expanding market share, including expansion through acquisitions, are expected to contribute to CHRW's future growth. The CHRW stock yields 2.2% on a payout ratio of 51%. Its dividends grew, on average, by 9.0% annually over the past five years. Trading above trucking industry valuation, the company looks expensive with 23.0x trailing and 20.7x forward earnings. Still, the company's forward P/E is lower than its five-year average. Fund managers Jason Capello, Ken Griffin and Steven Cohen were bullish about the company in the third quarter of last year.
Coach Inc. (COH), an "affordable luxury" apparel, footwear and accessories maker, also has almost no long-term debt. Its ROE is high at about 55%. The company's current ratio is 2.4, while its cash and equivalents share in total assets is 24%. The company generates consistent free cash flow; its free cash flow to net income ratio is 0.95. The company's EPS growth averaged a robust 16% annually over the past five years. EPS growth is expected to average 14.3% annually for the next half-decade. Analyst expectations are optimistic, based mainly on the rebound in U.S. sales, which account for the lion's share of total revenue, and on surging China growth. However, there are concerns that growing competition and the need for promotions to drive sales will cut into Coach's revenue and margins. Coach pays a dividend yield of 2.2% on a payout ratio of 34%. Its current quarterly dividend is four times the size of the quarterly dividend paid in 2009. COH is trading at 15.5x trailing and 13.9x forward earnings. However, it trades at a high price-to-book ratio of 7.9. Hedge funds Partner Fund Management (check out its top picks) and 3G Capital established new positions in the stock last quarter.