These 3 Companies Are Cash Cows
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
You have the choice of two different companies, tell me which one sounds better.
Company #1 – This company produces enough cash to pay the bills and expand and pays a good dividend. They also are committed to buying back shares. Finally, they know the importance of a strong balance sheet so periodically they will use extra cash to pay down debt or increase their cash position.
Company #2 – This company doesn't produce enough cash to pay the bills, but they can issue new stock or debt to continue expanding. They are probably a few years from reporting good earnings because their cost of expansion will continue to be high. In five years, this will be a great investment.
Most people would choose Company #1 for obvious reasons. However, in the stock market today there are multiple examples of companies like this, but they are overlooked in favor of the “next big thing.”
The biggest difference between these two types of companies is one generates significant free cash flow and the other does not. I know some growth investors are probably crying foul right now because they believe companies must burn through cash to grow. The problem is, as Peter Lynch said, if the company will be a great investment in five years, then wait five years. If the company isn't already doing it, or isn't making money, it's best to wait for positive earnings before jumping in. You might miss the initial move up, but if the company is worth investing in, your caution will save you from sometimes huge losses. Sticking with this theme, there are three companies I've identified that are like our proverbial Company #1 above. They are making money, two of the three pay dividends, two of the three are repurchasing shares, and each one has a strong balance sheet. The best part is, with the help of the Fool.com CAPS Screener, I can also report they are each down 20% or more from their 52 week high.
Our first contender is CA Technologies (NASDAQ: CA). This is a company involved in IT management as well as security applications and other software solutions. I'm going to spoil the surprise and suggest that this company make its way onto your Watchlist right now. I'm a big fan of growth and income stocks, and in CA Tech. you get both. Analysts are calling for earnings growth of about 9% over the next few years, and the stock is selling for less than 9 times forward earnings estimates. While 9% growth in earnings might not be enough for some, a 4.5% dividend yield makes this the stock to beat. The company's dividend is well covered also with an average payout ratio over the last year of less than 34% of free cash flow. Speaking of free cash flow, the company produces plenty of it. Over the last year, CA Tech. generated about $350 million in free cash flow per quarter. Relative to its market cap. of about $10 billion this is equivalent to 3.4% of its market cap being generated in cash every three months. In addition, the company is doing all the right things by using money not allocated for dividends on share repurchases. When you add in the fact that CA Tech. sits on just under $1 billion in cash and cash equivalents, you have the complete package.
In order of priority, I would put Infosys (NYSE: INFY) on your Watchlist second. The company operates in multiple fields like consulting, outsourcing, and IT. The biggest difference between Infosys and CA Tech. is Infosys is supposed to grow faster, but pays a lower yield. For investors looking for a slightly higher combined total return, Infosys beats CA Tech. Analysts are looking for 14.5% growth in the next five years, and with the stock selling for about 13.5 times projected earnings, it appears undervalued. The company's yield of 1.19% might not be as good as CA Tech., but the company's higher projected growth rate makes up for this lower income production. If there is one gripe I have about Infosys, it's that in the last year the company has not repurchased shares. The good news for investors is, they are sitting on over $3.2 billion in cash and investments, and the company produces about $850 million in free cash flow per quarter. This free cash flow production is actually slightly higher than CA Tech. relative to their market cap. at about 3.47%. The reason I'm not more impressed with the company is their yield is lower, the payout ratio is higher, and if they don't meet analyst expectations, CA Tech. would be the better value.
Third on my list is Teradata (NYSE: TDC). This company operates more in the storage and analytic solutions field and because of their focus on analytics and database management, one of their major competitors is Oracle (NYSE: ORCL). This is one reason I can't recommend Teradata even more highly. Oracle is a huge company that produces enough free cash flow ($3.3 billion) per quarter, that they could buy Teradata at current prices in just three quarters. When your competition makes enough in three quarters to cover your whole market cap., you know you are in for a tough fight. In addition, Oracle pays a dividend (0.75%) and Teradata does not. Honestly I'm not sure why that is. Teradata produced about $130 million in free cash flow on average in the last year, and they have grown their cash balance by over 30% in that timeframe. The company also has only repurchased shares in two of the last four quarters. This is another big difference. Oracle regularly repurchases shares, and just the cash and investments on Oracle's balance sheet is worth nearly two times Teradata's market cap. Last but not least, Oracle is cheaper than Teradata. Oracle is expected to grow only slightly slower, yet the shares sell for just 11 times projected earnings versus over 18 times earnings at Teradata.
The one thing that all of these companies have in common is they produce plenty of free cash flow. However, as we have seen not all the companies use their free cash flow in the same way. CA Tech. pays a good dividend, is buying back shares, and almost 10% of their market cap. is represented by the cash on their balance sheet. Use this information as a starting point for your own research, and decide if any of these companies deserves a spot in your portfolio. There are a lot of things to look at when trying to find a good investment, but there is a reason the saying goes, “cash is king.”
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Oracle. Motley Fool newsletter services recommend Teradata. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!