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What to Look for in a Cash Cow

There are any number of ways to assess a particular stock’s potential as a cash cow, but using some of the following criteria can help you narrow the field:

• Listing on the New York Stock Exchange (NYSE) or Nasdaq.
• A minimum market valuation of $250 million, although some analysts prefer a $500 million threshold. The $250 million minimum ensures stocks have enough liquidity to make them reasonable investments, while steering you to some quality issues that aren’t already household names.
• A low stock price-to-free-cash flow ratio. Two years ago, after the market collapse, there were plenty of companies around with a ratio of 2:1 or less. Now, you may have to consider a ratio of 10:1 to qualify some of the candidates that meet all the other criteria.
• Money in the bank – a balance sheet listing equal to 5% of the company’s assets is preferred.
• Free cash flow greater than 10% of sales revenue – the more free cash a company produces the better!
• Growing free cash flow of at least 5% of sales over the trailing 12-month period, and in each of the prior three years. This ensures that money from sales is the financial equivalent of a roaring river, rather than a trickling stream.
• High free-cash-flow yield. This is an indicator of free-cash-flow return relative to share price, 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. [Note: Some analysts prefer calculating free-cash-flow yield by dividing the company's total free cash flow by its enterprise value (EV) rather than market capitalization, since this accounts for numerous other factors, including debt, preferred shares, etc.]
• High free cash flow per share. This is cash from operations for the latest reported year, minus the same year’s capital expenditures and dividend payments, divided by shares outstanding.
• A balance sheet showing at least $500 million in cash and equivalents.
• Returns on equity of 12.5% or more, which will put the corporation in the top third of companies. This is an indicator that all the cash is being reinvested at a high return, and helps prevent sectors with low rates of return on equity across the board from putting lots of marginal companies on your list. Look for a trailing 12-month return on equity that is above average for the company’s industry.
• A current dividend providing a yield of 2.0% or more is nice, but not required.
• A healthy cash return – defined as free cash flow plus net interest expense, divided by enterprise value. Evaluating cash return can be a great first step in finding cash cows with reasonable prices, but it may not work that well for financials or foreign stocks. Cash flow is not terribly meaningful for firms that earn money via their balance sheets, and definitions of cash flow can vary widely in other countries. Thus, a foreign stock that looks cheap based on its cash return may simply be defining cash flow more liberally.

Most of the above numbers and valuations – or the figures needed to calculate them – can be found on the company balance sheets or the statistical sections of the “stock quotes” summaries on key financial websites such as MSN Money, Yahoo Finance or Forbes.com.

Seven Cash Cows to Start Your Search

Here are seven stocks you can look at as you begin your search for cash cows. Thanks to price increases generated by the market’s persistent rally in recent months, not all of them fulfill each of the criteria listed above (most notably exceeding the suggested price-to-free-cash-flow ratio), but all are close – and well worth watching.

Protective Life Corp. (NYSE: PL), recent price $24.15 – This regional life insurance and investment company had estimated year-end 2009 free cash flow of $1.144 billion, or $13.34 a share, providing a free-cash-flow yield of 55.2% and a price-to-free-cash-flow ratio of 1.81. Earnings per share were $3.34, the company had $49 worth of cash on hand per share, a dividend yield of 2.0% and a debt-to-equity ratio of 0.59.

Bank of America Corp. (NYSE: BAC), recent price $18.61 – Despite some much-publicized concerns and a sharp dividend cut in 2009, this banking giant continues to demonstrate cash-cow characteristics. At year-end 2009, BAC had an estimated free cash flow of $156.37 billion, or $15.59 per share, providing a free-cash-flow yield of 83.8%, with $52 per share in cash on hand. On the negative side, the company posted a 2009 loss of 26 cents a share, cut its dividend to just 4 cents for a yield of 0.2% and listed a fairly high debt-to-equity ratio of 2.62.

Constellation Energy Group, Inc. (NYSE: CEG), recent price $37.09 – This Baltimore-based supplier of energy products and services covers the United States, with a focus on the East Coast. At the end of 2009, it had an estimated free cash flow of $6.135 billion, or $30.37 a share, providing a free-cash-flow yield of 81.9% and a price-to-free-cash-flow ratio of 1.20. Earnings per share were $22.07, the company had just over $17 worth of cash on hand per share, a dividend yield of 2.6% and a debt-to-equity ratio of 0.55.

Barnes & Noble, Inc. (NYSE: BKS), recent price $22.33 – Though much of the publishing industry is beset by woes brought on by electronic media, this international bookseller continues to generate substantial cash. At year-end 2009, it had an estimated free cash flow of $414.7 million, or $7.15 a share, providing a free-cash-flow yield of 32% and a price-to-free-cash-flow ratio of 3.10. Earnings per share were $1.11, a dividend yield of 4.5% and a minuscule debt-to-equity ratio of 0.11. The only negative was that cash on hand was just 70 cents per share.

Whirlpool Corp. (NYSE: WHR), recent price $96.09 – This major home appliance maker had a free cash flow of $848.25 million, or $11.31 per share, at the end of 2009, providing a free-cash-flow yield of 11.77%. Earnings per share were $4.34, WHR had $18.45 a share in cash on hand, a dividend yield of 1.8% and a debt-to-equity ratio of 0.79.

PHH Corp. (NYSE: PHH), recent price $24.78 – Despite the well-publicized problems in the housing market, this New Jersey-based provider of mortgage and credit services continues to throw off plenty of cash. At year-end 2009, it had an estimated free cash flow of $1.277 billion, or $23.22 a share, providing a free-cash-flow yield of 93.7% and a price-to-free-cash-flow ratio of just 1.10. Earnings per share were $2.75 and it had cash on hand of $2.72 a share. Minuses include the lack of a dividend and a fairly high debt-to-equity ratio of 3.46.

Zions Bancorporation (Nasdaq: ZION), recent price $27.42 – Like Bank of America, this Utah-based regional bank showed an operating loss for 2009, but its cash-flow numbers remained healthy. With an estimated $1.714 billion in free cash flow, or $10.85 a share, ZION had a free-cash-flow yield of 39.6% and a price-to-free-cash-flow ratio of 2.70. The loss per share was $3.59 and it had cash on hand of $8.67 a share. The only negative besides the loss is a tiny dividend yield of 0.1%.

Regards,

Don