Related Articles
10 big, fat cash cows
Related Resources
Decision Center: Find hot stocks
Stock Research
Jubak's Journal
Recent articles:
• 5 ways to play the Bush budget, 2/9/2005
• 12 global growth stars you've never heard of, 2/8/2005
• 5 stocks for an up-and-down year, 2/4/2005
More...
| | Jubak's Journal
15 cash cows that outperform the herd
My '10 cash cows' list from 2003 has put up impressive returns, so I've decided to round up a new herd of 15. What I look for: Companies with ample cash flows.
By Jim Jubak
Cash is king? Wait. Not that cash. Not the kind that you stuff in mattresses or put into money market accounts yielding 2%.
No, I'm talking about the kind that companies generate and then reinvest to produce even more cash.
And the cash that investors can make by investing in the shares of companies that generate the best cash flows.
So maybe I really ought to say, "Cash cows are kings."
How do I know? Well, the "10 cash cows" portfolio I put together in my Oct. 21, 2003, column gained 25% from inception through the market close on Feb. 7 of this year. That beats the 15% gain on the Standard & Poor's 500 ($INX) stock index and the 8% gain on the Nasdaq Composite ($COMPX) index for that same period.
Adding to the herd
This outperformance deserves an encore. So I'm going to run my cash-cow screen again and give you another list, this time of 15 cash-cow stocks -- eight holdover stocks from the original list and seven new ones -- to stuff in your portfolio for the next 15 months or so.
Why does buying cash-cow stocks work? These are companies that send a high percentage of each dollar in sales straight to the bottom line, that show big cash flows even after investing in their own business, and that earn top returns on that reinvested capital.
When you find one of these, hold on until the cash starts to dry up. Each year you own one of these cash cows, you multiply your returns as the business generates a flood of cash and then reinvests that to earn a mouth-watering return. It's called compounding, and it works even more powerfully when the return on reinvestment is 15% or more than when it's 2% on a savings account.
How the original 10 did
In October 2003 I used a screen to find 10 cash cows for long-term investors that weren't on most investor's radar screens. Here are the 10 stocks from that original list and their gain or loss from Oct. 21, 2003, through Feb. 7, 2005.
| Milking the cash cows | | Company name | Market cap ($billions) | Recent price (2/7/2005) | Purchase price | Gain/loss | | Alcon (ACL, news, msgs) | $17 | $81.53 | $57.06 | 42.90% | | EnCana (ECA, news, msgs) | $18 | $60.27 | $37.02 | 62.80% | | H&R Block (HRB, news, msgs) | $8 | $47.42 | $47.90 | -1.00% | | Harley-Davidson (HDI, news, msgs) | $15 | $61.17 | $47.78 | 28.00% | | Landauer (LDR, news, msgs) | $0.30 | $47.74 | $37.03 | 28.90% | | Mentor (MNT, news, msgs) | $1 | $35.38 | $23.97 | 47.60% | | Paychex (PAYX, news, msgs) | $14 | $30.81 | $37.34 | -17.50% | | SEI (SEIC, news, msgs) | $4 | $37.15 | $32.48 | 14.40% | | Strayer Education (STRA, news, msgs) | $1 | $113.59 | $94.40 | 20.30% | | William Wrigley Jr. (WWY, news, msgs) | $10 | $69.62 | $56.37 | 23.50% |
|
| Comparing the gains | | Portfolio / index | Gain | | Cash Cow portfolio | 25% | | Standard & Poor's 500 ($INX) | 15% | | NASDAQ Composite ($COMPX) | 8% |
|
10/21/2003 - 2/7/2005
What makes a cash cow?
Every company would be a cash cow if it could. The formula isn't exactly a secret -- it's just very tough to execute. All you need is a business:- that has a base of recurring revenue, so you don't have to replace your customers every quarter;
- that is at the same time relatively easy to expand with the addition of capital;
- and that commands high margins because the company has built significant barriers to competitors moving into the field.
William Wrigley Jr. (WWY, news, msgs), from the 2003 list, is a classic example. The company's dominant share in the gum market lets Wrigley outspend its competitors and out-distribute them while keeping costs very low per package of gum because the company's base of sales (its trailing 12-month sales figure is $3.5 billion) is so large. That's also a lot of gum.
And it creates a lot of cash flow. Operating cash flow over the trailing 12 months was $749 million, or about 21% of sales. Free cash flow came in at $503 million, or 14% of sales. And remember that Wrigley pays a dividend of $1.12 a share, for a yield of about 1.6%, as well.
Sales have grown at an average of 9%, and operating income at an average of 8%, annually over the last five years. That rate has picked up lately to 13% for sales and 11% for operating income in the last quarter on a year-to-year comparison.
Wolverine World Wide (WWW, news, msgs), which joins the cash cow list this time around, is a much smaller company with numbers in the same class. Operating cash flow in the trailing 12 months was $136 million, or about 14% of the company's $967 million in sales. Free cash flow of $118 million was about 12% of sales. Sales have grown an average of 5.8% annually over the last five years, but that rate has picked up to 11.8% in the most recent trailing 12-month period. Operating income jumped 25.5% year over year in the most recent quarter.
Narrowing down the field
How did I pick these cash-cow stocks? By saying "Show me the money" over and over again. To start with, these companies had to have cash on their balance sheets equal to 5% of the value of their assets. There's nothing like starting with a pile of cash if you're looking for evidence that a company can generate lots of cash.
Then they had to show growth in free cash flow over the trailing 12-month period, and free cash flow had to amount to more than 5% of sales in each of the last three years. That way I could be certain that the money from sales was dropping to the bottom line in something like the financial equivalent of a flood rather than a trickle.
To make sure that all this cash was being reinvested at a high return, I looked for a trailing 12-month return on equity that was greater than the average for the company's sector. So that sectors with low rates of return on equity across the board didn't wind up putting lots of companies on this list, I also required that any company show a return on equity of 14.84% or better. That would put the company in the top 25% of all companies on this measure of profitability. And just to make sure that I leveled the playing field between companies that use equity and debt financing, I also required companies to show a return on assets of 6.61% or better, enough to rank them in the top 25% of companies on that measure, too.
Finally, to make sure that these stocks had enough liquidity to make them reasonable investments, I eliminated all stocks with a market capitalization of less than $390 million (that's the cutoff for the lowest 50% of all market capitalizations). And ruled out any stock with a market capitalization above $20 billion to make sure I turned up some unfamiliar names.
By the way, big companies that would have made the cash-cow list except for their size include Avon Products (AVP, news, msgs), Cisco Systems (CSCO, news, msgs), Intel (INTC, news, msgs), Johnson & Johnson (JNJ, news, msgs), PepsiCo (PEP, news, msgs), Procter & Gamble (PG, news, msgs) and 3M (MMM, news, msgs).
It was actually harder to make the list this February than in October 2003. The required return on equity to make the top 25% of all companies jumped to 14.84% this year from 13.75% as a result of the continuing rebound in corporate profits. The cutoff on return on assets climbed as well to 6.61% from 5.05% in 2003.
Two of the stocks on the October 2003 list, EnCana (ECA, news, msgs) and H&R Block (HRB, news, msgs), didn't make the cut this time. I'm going to replace them with two stocks and then add five more, bringing the Cash Cows portfolio up to 15 stocks.
And the new entries are . . .
My seven new cash cow picks are:- Cognizant Technology Solutions (CTSH, news, msgs)
- Infosys Technologies (INFY, news, msgs)
- Paccar (PCAR, news, msgs)
- Plum Creek Timber (PCL, news, msgs)
- Shuffle Master (SHFL, news, msgs)
- Teva Pharmaceutical Industries (TEVA, news, msgs)
- Wolverine World Wide (WWW, news, msgs)
As always, please remember that screens like this are just a starting point for doing due diligence on a stock. They're not a substitute for digging into the guts of a company.
But they do provide a guide for what to look for. Just keep saying "Show me the money" as you look for true cash cows for the long run.
New developments on past columns
The best odds in Las Vegas
Great times for Station Casinos (STN, news, msgs) are actually getting better. On Jan. 24, the company announced earnings for the fourth quarter of 2004 of 58 cents a share, 7 cents above the Wall Street consensus. Revenues climbed by 15% above those in the fourth quarter of 2003 to $265 million, about 5% above Wall Street projections. The company also raised guidance for the first quarter of 2005 from 56 cents to 62 cents, well above the Wall Street consensus of 55 cents. The company's bet on the local Las Vegas economy looked even smarter in the quarter, too. Station Casinos bucks the Las Vegas trend by building hotels and casinos off the Las Vegas Strip that cater to locals rather than out-of-town gamblers. In the fourth quarter, the number of people moving to Las Vegas climbed to 9,000 per month, well above the 6,000-per-month total in the first half of the year. I guess job hunters noticed that the local unemployment rate is below 4% while the national rate is above 5%. As of Feb. 11, I'm raising my target price on Station Casinos to $69 by July 2005 from the previous target of $59 by December 2004. (Full disclosure: I own shares of Station Casinos.)
Editor's Note: A new Jubak's Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Encana, PepsiCo and Station Casinos. He does not own short positions in any stock mentioned in this column.
|
