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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

(Read the Rest of the Article…)

Regards,

Don