Many investors prefer using free cash flow instead of net income to measure a company's financial performance because free cash flow is more difficult to manipulate. Free cash flow is the operating cash flow minus capital expenditure.
I have searched for very profitable companies that pay rich dividends with low payout ratio, and that have a very low price to free cash flow. Those stocks would have to show also a very low trailing and forward P/E.
I have elaborated a screening method, which shows stock candidates following these lines. Nonetheless, the screening method should only serve as a basis for further research. All the data for this article were taken from Yahoo Finance and finviz.com. The screen's formula requires all stocks to comply with all following demands:
- Price is greater than 2.00.
- Market cap is greater than $100 million.
- The forward dividend yield is greater than 2.90%.
- The payout ratio is less than 40%.
- Price to free cash flow for the trailing 12 months is less than 7.00.
- Price to cash is less than 5.00.
- Trailing P/E is less than 7.
- Forward P/E is less than 8.
After running this screen on August 30, 2013, before the market open, I discovered the following three stocks:
HCI Group, Inc. (HCI)
HCI Group, Inc., an insurance holding company, provides property and casualty insurance in Florida.
HCI Group has a very low debt (total debt to equity is only 0.26), and it has a very low trailing P/E of 6.65 and a very low forward P/E of 7.89. The price-to-cash ratio is extremely low at 1.12, and the price to free cash flow for the trailing 12 months is also very low at 2.98. The forward annual dividend yield is at 2.91%, and the payout ratio is only 19.31%.
HCI Group has recorded strong revenue and EPS growth, during the last year, the last three years and the last five years, as shown in the table below.
On August 01, HCI Group reported its second-quarter financial results, which beat EPS expectations by $0.18. The company reported income available to common stockholders in the second quarter of 2013 totaled $16.2 million or $1.40 diluted earnings per common share, an improvement from $7.2 million or $0.74 diluted earnings per common share in the second quarter of 2012. Gross premiums earned in the second quarter of 2013 increased 52.4% to $82.0 million from $53.8 million in the same period in 2012. The increase was primarily due to policies assumed from Citizens Property Insurance Corporation in November 2012.
HCI has recorded very strong revenue and EPS growth, and considering its compelling valuation metrics, HCI stock can move higher and reach its target price of 39.50 soon (a 27.5% rise). Furthermore, the rich dividend represents a nice income.
Since the company is rich in cash ($27.77 a share) and has a low debt and its payout ratio is very low, there is hardly a risk that the company will reduce its dividend payment.
Main risk to HCI stock is big losses in the event of severe hurricanes storms.
PDL BioPharma, Inc. (PDLI)
PDL BioPharma, Inc. engages in intellectual property asset management and patent portfolio and related assets investment activities.
PDL BioPharma has an extremely low trailing P/E of 4.85 and even lower forward P/E of 4.08. The price-to-cash ratio is at 4.24, and the price to free cash flow for the trailing 12 months is very low at 6.57. The PEG ratio is exceptionally low at 0.35, and the average annual earnings growth estimates for the next five years is quite high at 14%. The forward annual dividend yield is very high at 7.63%%, and the payout ratio is only 37%.
PDL BioPharma has recorded good revenue and EPS growth, during the last year, the last three years and the last five years, as shown in the table below.
On August 8, PDL BioPharma reported its second-quarter financial results, which beat EPS expectations by $0.08 and was in-line on the company revenues' guidance. Royalty revenues for the second quarter of 2013 increased 14 percent to $143.6 million from $125.9 million reported in the second quarter of 2012. Net income for the second quarter of 2013 was $93.7 million, or $0.62 per diluted share, as compared with net income of $73.5 million, or $0.52 per diluted share, in the same quarter of 2012.
Increased royalties on sales of Avastin, Herceptin, Lucentis, Actemra and Tysabri drove second-quarter 2013 royalties. Effective from the second quarter of 2011, PDL BioPharma started paying back a portion of the royalties it receives on Lucentis sales outside the U.S. to Novartis. The payment is made in accordance with a settlement agreement, which the companies had entered into in February 2011.
In April 2013, PDL BioPharma entered into a credit agreement with Avinger Inc. PDL BioPharma paid $20 million in cash on April 18, 2013 and is expected to provide additional funds of around $20 million on achieving certain specified revenue milestones. As per the agreement, PDL BioPharma will be receiving interest on the principal amount outstanding along with a low, single-digit royalty on the sale of Avinger's suite of products till April 2018.
PDL BioPharma has recorded strong revenue and EPS growth, it has extremely strong fundamentals, and it pays a very rich dividend with a low payout ratio. The only concern about the stock is patents expiration next year, but the company has entered into new agreements lasting well into 2020. The PDLI stock has retreated 7% from its high value this month, but, in my opinion, at this level PDLI stock still has room to go up.
Nevsun Resources Ltd. (NSU)
Nevsun Resources Ltd., a gold and base metal mining and exploration company, together with its subsidiaries, engages acquisition, exploration, development, and production of mineral properties in Africa.
Nevsun Resources has no debt at all, and it has an extremely low trailing P/E of 5.47 and a very low forward P/E of 5.65. The price-to-cash ratio is very low at 1.85, and the price to book value is also very low at 0.98. The price to free cash flow for the trailing 12 months is very low at 6.82, and the current ratio is very high at 16.60. The forward annual dividend yield is high at 4.49%, and the payout ratio is only 25%.
Analysts recommend the stock. Among the 4 analysts covering the stock, one rates it as a strong buy, two rate it as a buy, and one rates it as a hold.
Nevsun Resources has recorded strong EPS growth, during the last three years and the last five years, as shown in the table below.
The NSU stock is trading 35% below its 52-week high, and has 41% upside potential based on the consensus mean target price of $4.40.
On August 7, Nevsun Resources reported its second-quarter results.
Second quarter 2013 highlights
- Produced 34,900 ounces of gold
- Revenues of $54.8 million on 36,200 ounces gold
- Cash cost of $692 per ounce of gold sold
- Net income attributable to Nevsun shareholders was $5.3 million, $0.03 per share
- Copper flotation plant completed on time and under budget
- Commenced copper plant commissioning with pyrite sand
- Maintained strong balance sheet with approximately $384 million in working capital
- Announced 40% increase of semi-annual dividend to $0.07 per share
- Safety milestone reached - 12 million man hours without a lost time injury
NSU has recorded very strong EPS growth, and considering its extremely cheap valuation, and the fact that the stock is trading below book value, NSU stock can move higher and reach its target price of 4.40 soon (a 41% rise). Furthermore, the very rich dividend represents a nice income.
Since the company is rich in cash ($1.68 a share) and has no debt and its payout ratio is very low, there is a hardly risk that the company will reduce its dividend payment.
Main risk to NSU stock is a strong decline in the price of gold.