Investors love cash cows – companies that generate consistent free cash flow. FCF, as it is often abbreviated, is what is left over or "free" from operating cash flow after deducting capex payments and working capital requirements. These stocks tend to do well over time.
This is because firms with high FCF margins (i.e., free cash flow as a percentage of sales) can afford to make dividend payments and acquisitions, buy back stock, reduce debt, or just let the cash pile up on the balance sheet.
The average operating profit margin for the S&P 500 was 12.7% in 2022, according to Yardeni Research. (Operating margins are typically higher than FCF margins as they don't include capex and working capital expenses as do FCF margins.) So generally, any company with a 20% or greater FCF margin can be considered a cash cow.
What's more, these tend to be the best dividend stocks, consistently growing their payouts and earnings per share over time. This is partly because through stock buybacks, the denominator, or the shares outstanding, drops over time.
With this in mind, here are six of the best cash cows to buy now. To find the best stocks to buy, we looked for companies that generate impressive free cash flow and put it to good use via dividends, buybacks and more. Plus, each has a high FCF margin and yield, which indicates it will do well over the long term.
Data is as of November 7. FCF margins are calculated by dividing a company's last 12 months (LTM) free cash flow by its LTM sales. FCF yield is the last 12 months free cash flow divided by the market value of the stock.
Palo Alto Networks
- Market value: $74.7 billion
- LTM FCF margin: 37.7%
- LTM FCF yield: 3.5%
Palo Alto Networks (PANW, $242.08) is a cybersecurity software company that generated $2.6 billion in free cash flow over the 12 months ended July 31. Since Palo Alto Networks also produced $6.9 billion in LTM revenue, its FCF works out to 37.7% of its sales. This FCF margin easily makes PANW a very prosperous cash cow.
Moreover, since PANW stock has a market capitalization of $74.7 billion, its FCF yield is 3.5%. So, here we have the best of both worlds, a cash cow and a low valuation.
Palo Alto Networks has been around since 2005, which is a long time in software years. Moreover, its sales have more than doubled since fiscal 2019, showing that its products are relevant to companies that need software security products and services from them.
However, although Palo Alto Networks does not pay a dividend, it has been aggressively buying back its stock. For example, in the last year, it repurchased $943 million of its shares, and after net of stock issuance, this was $806 million. That is just over 1% of its stock market capitalization. But it still means that $1.8 billion was left over from the $2.7 billion in FCF.
So, what has Palo Alto Networks been doing with its excess FCF, after its buybacks?
It's piling the cash up. It turns out this top cybersecurity stock is a defensive company that is simply storing its cash by buying long-term investments. In the last year, long-term investments have risen by almost $2 billion, from around $1.05 billion to $3.05 billion as of July 31. That accounts for most of the excess FCF and shows that Palo Alto Networks is a cash cow.
In total, PANW now has $6.0 billion in cash and investments, or 8% of its stock market valuation. At this pace, in four years, the cash could be worth much more.
- Market value: $2.68 trillion
- LTM FCF margin: 30.0%
- LTM FCF yield: 2.4%
Microsoft (MSFT, $360.53) is a major software company that operates in every key area of the software industry: operating systems, cloud, gaming, application software and artificial intelligence (AI).
MSFT's powerful free cash flow of $63.2 billion over the last 12 months was more than sufficient to cover its dividends, share repurchases, acquisitions and debt reduction. Moreover, it represents 30.0% of its $218.3 billion in revenue over the past year. That clearly puts it in cash cow status, as this is well over 20%.
In addition, compared to its market capitalization of $2.68 trillion, the more than $63 billion in LTM FCF represents a 2.4% FCF yield. That makes it one of the best cash cows to buy.
In addition, Microsoft is using its FCF to cover its dividend and buybacks. It pays a $3.00 per-share annual dividend, up 10.3% over last year. The $63 billion in FCF more than covers the annual dividend cost as well as tens of billions of dollars the company spends on share buybacks.
Microsoft's Office, LinkedIn and cloud services products (Productivity and Business Processes division) enjoy strong appeal with consumers (up 7% in the latest quarter). In addition, its Intelligent Cloud revenue jumped 18% in the last quarter.
Still, the Dow Jones stock is relatively expensive, trading at 34.9 times earnings forecast for this fiscal year, and 30.4 times earnings for the next fiscal year. Both figures are above the company's five-year averages.
Still, given its cash cow status and high FCF yield, investors might expect that MSFT stock will continue to do well.
- Market value: $370.6 billion
- LTM FCF margin: 49.0%
- LTM FCF yield: 4.7%
Broadcom (AVGO, $897.82) is a semiconductor manufacturer with a diversified client base that includes Apple (AAPL) and its smartphones. It also serves markets such as networking and cloud. In addition, AVGO is looking to close on its $60 billion acquisition of VMware (VMW), a software and cloud management company, though the deal is facing regulatory scrutiny.
In the last 12 months ending October 31, Broadcom generated $17.4 billion in free cash flow. Comparing that to its LTM revenue of $35.5 billion shows that its FCF margin is an amazing 49.0%. That makes it one of the best cash cows in the S&P 500. In fact, in the company's latest quarter, its FCF rose 6.7% year-over-year.
Moreover, AVGO stock is still a cheap stock. Given that its market cap is roughly $370 billion, this means its FCF yield is healthy at 4.7% (i.e., $17.4 billion/$370.6 billion).
So, here we have an amazing cash cow company that has a cheap valuation with a 4.7% FCF yield – again the best of both worlds.
Of course, the market is still waiting for the VMware acquisition to close. Broadcom says it expects to close the deal sometime in its fiscal year ending in January 2024.
In the meantime, shareholders are happy to receive the company's $18.40 per-share annual dividend, which is up 12% over last year. More importantly it gives AVGO stock a 2.1% yield – pretty impressive for a tech stock. Broadcom uses its $17 billion in FCF to cover the annual cost of the dividend which is about $7.7 billion.
Moreover, it is spending $4.7 annually on share buybacks on top of $1.3 billion for share awards. Plus, Broadcom is focusing about $1 billion toward debt reduction. All of these are uses of its abundant FCF and show that the company is clearly working on behalf of its shareholders.
All in all, Broadcom is one of the best cash-cow and high FCF-yield stocks in the S&P 500.
- Market value: $1.64 trillion
- LTM FCF margin: 26.1%
- LTM FCF yield: 4.7%
Alphabet (GOOGL, $130.97) is one of Wall Street's top cash cows because it brings in large amounts of free cash flow. This search engine and cloud software giant generated $77.6 billion in FCF in the last 12 months. Given its LTM sales of $297.1 billion, this puts its FCF margin at 26.1%. Generally, any company with a FCF margin over 20% is considered higher than average.
While advertising revenue growth based on search stayed in the single digits last quarter, the company's Google Cloud has been more than making up it. For example, in Q3, the 22% revenue growth in Google Cloud helped lead to 11% growth in total revenue.
And this is what is helping Google's FCF stay strong. Moreover, the company is addressing potential cash flow issues, including with its decision to lay off 12,000 people, or 6% of its global workforce, earlier this year.
Nevertheless, Alphabet is putting its FCF to good use to help shareholders. Although it does not pay dividends, it has spent $45.3 billion on stock buybacks so far this year. This represents a little over half of its FCF over the past year.
The retiring of such a substantial amount of stock suggests that earnings per share could rise even if net income stays the same. It also means that shareholders have a bigger stake in the company. This is why cash cows like GOOGL are worth buying.
- Market value: $40.7 billion
- LTM FCF margin: 35.3%
- LTM FCF yield: 4.4%
Paychex (PAYX, $112.53) is a human resources, payroll, benefits and insurance services company for small to medium-sized businesses in the United States, Europe and India.
The company reported solid earnings and cash flow in late September for its fiscal first quarter. Its operating cash flow $655.8 million, up 80% year-over-year. Moreover, in the last 12 months ending May 31, its FCF was $1.8 billion on sales of $5.1 billion. That gives it a massive FCF margin of 35.3%, which makes Paychex a legitimate cash cow.
And given that its market capitalization is just $40.7 billion, this gives it an attractive FCF yield of 4.4% (i.e., $1.8 billion / $40.7 billion).
Analysts expect the company to show earnings of $4.71 per share this fiscal year and $5.02 per share next year. That means at today's price, PAYX stock is moderately expensive on a price-to-earnings basis, though these valuations are still below the company's five-year averages.
The bottom line is that small and medium businesses continue to grow and need HR and the kind of payroll services that Paychex offers its clients.
PAYX pays a $3.56 per-share annual dividend, which costs the company about $1.3 billion of the $1.8 billion in LTM FCF. That gives PAYX stock a 3.2% dividend yield based on its current price. In addition, Paychex has been spending $145 billion annually on share buybacks.
Given its solid revenue growth, operating margins, free cash flow, dividends and buybacks, Paycheck stock looks like one of the best cash cows to buy now.
- Market value: $71.7 billion
- LTM FCF margin: 42.2%
- LTM FCF yield: 12.1%
Altria Group (MO, $40.51) sells smokable and oral tobacco products. Of course, its Marlboro brand is iconic throughout the world. This is a hold-your-nose kind of stock, especially if you think its products do nothing to help humanity. And it probably doesn't fit into ESG-sensitive portfolios.
Nevertheless, it is a massive cash cow and as such we simply can't ignore it, especially for anti-ESG investors, or those who simply don't care about ESG. For example, Altria's LTM free cash flow is $8.7 billion on $20.6 billion in sales. That puts its FCF margin at a whopping 42.2%.
Altria is using that FCF for shareholders. As of June 30, it had $528 million left on its $1 billion share purchase program and has been spending between $1.8 billion and $2 billion annually on stock buybacks.
In addition, its annual dividend cost just under $7 billion based on its annual rate of $3.92 per share. That gives MO an ample dividend yield of 9.7%, which makes it one of the highest-yielding stocks in the S&P 500.
As a result, investors can expect that $8.7 billion in free cash flow is used up by at least $1 billion to $2 billion in buybacks, and $7 billion in dividend payments.
And given that MO stock trades at just 8.3 times earnings this year and 9 times next year's earnings, it is one of the cheapest cash cows to buy right now.
Mark R. Hake, CFA, is a Chartered Financial Analyst and entrepreneur. He has been writing on stocks for over six years and has also owned his own investment management and research firms focused on U.S. and international value stocks, for over 10 years. In addition, he worked on the buy side for investment firms, hedge funds, and investment divisions of insurance companies for the past 36 years. Lately, he is also working as Chief Strategy Officer for a tech start-up company, Foldstar Inc, based in Princeton, New Jersey.
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