By Larry D. Spears
The logic is sound: Especially during times of economic uncertainty, companies that have a lot of cash on hand have the flexibility to do all sorts of things - most of them ultimately beneficial to shareholders because they help increase earnings and lead to higher stock prices.
For example, cash-rich firms can invest in new plants and equipment, fund research-and-development (R&D) initiatives for new products, or finance acquisitions that will increase market share or expand their geographic reach.
So-called "cash-cow" firms can also use their accumulated reserves to pay down or eliminate existing debt, increase annual dividends, buy back stock - or simply hold the money as a cushion against further economic downturns. Excess cash in the vault can transform smaller companies into attractive takeover targets, providing the shareholders of those target companies with quick and sizeable capital gains.
Historically, finding true "cash cows" hasn't been all that easy. In healthier economic times, keen competition demanded consistent corporate outlays to pay for rapid growth, and shareholders expected steady dividend increases to make stock yields competitive with those of other high-interest investments.
These days, though, that's much less the case. More and more U.S. corporations, faced with economic uncertainties and a lack of high-return investment opportunities, are opting to maintain hefty cash reserves instead of spending to hire or expand.
In fact, a recent survey by Moody's Investors Service Inc. found that U.S. corporations - not including financial companies such as banks and brokerages - are currently holding liquid reserves in the form of cash and short-term investments of nearly $1 trillion. That represents an increase of 21% from the end of 2008.
U.S. financial firms are estimated to hold an additional $850 billion in cash equivalents.
The increased cash holdings are particularly evident among larger companies, with 20 major players in the technology, pharmaceutical, energy and consumer sectors holding more than 37% of the $943 billion in cash reported by Moody's. Four high-profile stalwarts - Apple Inc. (Nasdaq: AAPL), networking giant Cisco Systems Inc. (Nasdaq: CSCO), Microsoft Corp. (Nasdaq: MSFT) and Internet-search heavyweight Google Inc. (Nasdaq: GOOG) - alone account for $156 billion of the total.
By contrast, cash-rich companies are far harder to find in the natural products, environmental, aircraft and aerospace sectors.
Of course, merely having a pile of cash in the corporate kitty doesn't automatically make a company's stock a great investment. For that, you need other incentives, such as an attractive trading price, a high return on equity (ROE), a strong return on assets (ROA) or, perhaps most importantly, plenty of free cash flow (FCF) - generally defined as cash left over from operations, minus capital expenditures.
Specific criteria that can help you identify potential "cash cow" candidates include:
- Listing on the Nasdaq or the New York Stock Exchange.
- A minimum market valuation of $250 million - although a market cap of $500 million is even better.
- Cash on hand or cash equivalents equal to at least 5% of the company's assets.
- Free cash flow greater than 10% of sales revenue (the more the better), a free cash flow growth rate of at least 5% of sales over the past 12 months and a low stock price-to-free-cash-flow (P/FCF) ratio of no more than 10:1.
- A high free-cash-flow yield. This is an indicator of free-cash-flow return relative to share price, and is calculated by dividing the trailing 12-month period free cash flow per share by the most recent share price. The bigger the ratio, the better, since you want the most cash flow at the lowest possible price.
- Returns on equity of 12.5% or more, which will put the corporation in the top third of all companies. This is an indicator that all the cash is being reinvested at a high return.
- A current dividend yield of 2.0% or more is also nice, but not required.
Most of the above numbers and valuations - or the figures needed to calculate them - can be found on the companies' balance sheets or in the statistical sections of the "stock quotes" summaries on leading financial Websites such as Google Finance, MSNMoneycentral, Yahoo! Finance or Forbes.com.
Following are three companies that currently meet most - if not all - of these criteria. That turns this trio into an excellent starting point for investors wishing to add a few cash cows to their portfolios.
The three companies consist of:
- VeriSign Inc. (Nasdaq: VRSN), recent price $34.75: VeriSign is the leader in providing online security software and safety certificates to merchants and other institutions for Web-based purchases and other financial transactions. The company posted its third-quarter earnings Thursday, reporting revenue of $172.6 million, up 10% from the year-ago quarter and slightly above analyst expectations. Profits were 28 cents a share, a penny above forecasts. The company reported an additional net gain of $737 million on the sale of its authentication-services business. With a market capitalization of just over $6.0 billion, VeriSign's present holding of $1.34 billion in cash ($7.68 per share) represents 22.3% of its market valuation and more than 60% of its current net assets. Return on equity was 39.26% for the past 12 months, while return on assets was 9.17%. The company had free cash flow of $278 million for its 2009 fiscal year, $224 million of which was used for a share repurchase program this year. The stock has climbed steadily from a July 6 low of $25.94, but still looks attractive in spite of not paying an annual dividend.
- Analog Devices Inc. (NYSE: ADI), recent price $33.67: Analog Devices is the global leader in performance-signal-processing solutions (amplifiers and noise suppressors), and also manufactures digital converters, micro-controllers, an assortment of sound-and-data sensors and adapters and other microchip-based products. ADI has levered free cash flow of $644.3 million and current cash holdings of $2.51 billion, or $8.41 a share - more than 61% of assets. ROE for the trailing 12 months was 21.55%, while ROA was 12.85%. The stock has had a nice run-up from its most recent low of $27.89 on July 6, but the forward P/E is still just 13.2 and the dividend of 88 cents per share (raised from 80 cents in May) provides a yield of 2.6%. The company's fiscal year ended Sunday, so any pleasant earnings surprise for the fourth quarter could push the stock to new 52-week highs.
- Whirlpool Corp. (NYSE: WHR), recent price $75.83: The shares of this major home appliance maker have been restrained somewhat by the slower-than-expected U.S. economic recovery and the ongoing crisis in the housing and mortgage markets. However, that hasn't kept the company from amassing a substantial cache of cash. When its second quarter ended on June 30, Whirlpool reported free cash flow of $1.28 billion, with $850 million (the equivalent of $11.18 per share) in cash assets on hand. With trailing 12-month revenue of $18.7 billion and earnings per share of $7.17, Whirlpool has a forward P/E ratio of just under 8.2. ROE for the trailing 12 months was 15.58%, while ROA was 4.69%. Any pickup in the economy heading into the holiday season could give Whirlpool's stock the boost it needs to return to the high of $112.42 it hit in April. And even if it doesn't, the annual dividend of $1.72 provides a yield of 2.25%.
If you're interested in tapping into some of the cash held by companies in the financial sector, two other stocks you might consider are:
- CME Group (NYSE: CME), recent price $289.65: Overseer of the largest commodity trading arena in the world, CME Group had levered free cash flow of $1.23 billion at the end of the second quarter, cash on hand of $408.6 million, and the $4.60 annual dividend represented a yield of 1.6%. The stock traded at better than $340 a share in April.
- Zions Bancorporation (Nasdaq: ZION), recent price $20.75: Utah-based Zion showed an operating loss of $3.06 per share for the trailing 12 months ended Sept. 30, but a lot of that is due to bookkeeping as opposed to operational issues. ZION had revenue of $2.3 billion over the same period, and the bank currently has nearly $5.7 billion in cash on hand - equal to a whopping $32.10 per share - versus debt of just $2.9 billion. Book value per share for the most recent quarter was $26.07, meaning buyers at current prices are getting roughly $5 in assets for free.