With the ink dry on 2013 financial results, investors can get
a fresh gauge on how companies fared over the past year.
#-ad_banner-#By and large, 2013 a very good year for corporate
America, as profit margins hit all-time highs in many industries.
Yet not every company manages to translate robust margins into
cash in the bank. Many times, operating profits will be
squandered and the actual free cash flow (operating cash flow
minus capital expenditures) a company produces can be
The real stars of 2013 are the companies that focused on
delivering peak robust free cash flow (
), which sets the stage for a set of shareholder-friendly perks
that we refer to as
. A company with solid FCF can boost the dividend, buy back
stock, pay down debt -- or all three. There's often even enough
money left over for acquisitions.
Of course simply looking at FCF by itself isn't always
, for example, generated an impressive $11 billion in FCF in
2013, but that's just a fraction of the company's $376 billion
market value. Instead, it's wise to look at FCF in relation to a
company's value. If you can find a company with a FCF yield (FCF
divided by market value) in excess of 10%, it's invariably a
I went in search of great FCF yields among the stocks in the
S&P 400, 500 and 600, eliminating any companies from
contention that generated negative FCF in any of the past three
years. I also excluded banks from my search, as many banks took
steps to shore up their capital bases, which led to an
artificially high FCF reading in 2013. What's left is 31
companies, nearly half of which are in the insurance
Frankly, this is a great time to be focusing on insurers.
These companies are performing well now, and are poised for even
better days ahead. A firming economy will give them pricing
power, and rising interest rates will help them earn more on
their hefty cash balances.
Before I move on to other industries, I want to add another
test to these insurers. Many of them are using their prodigious
FCF for share buybacks, and I'm especially keen to see buybacks
when shares trade below book value. The math on such buybacks is
Let's look at the top five insurers in terms of price-to-book
The fact that
Reinsurance Group of America (NYSE:
trades for less than tangible book value and sports a 30% FCF
yield makes this company one of the top bargains in the entire
Outside of the insurers, there are 17 other companies that
sport double-digit FCF yields (again excluding any company that
has generated negative FCF in any of the past three years).
To be sure, some of these firms' high FCF yields are due to
repressed market values. Investors anticipate slow growth for
them in coming years, and thus assign a low valuation to them.
, for example, have all reached maturity, which has led
growth-oriented investors to shun them. Still, each of these
companies produces such powerful free cash flow that they are
capable of being among the best Total Yield plays on the
My personal favorite on this list is
Valero Energy (NYSE:
, simply because the economic backdrop for energy refiners will
keep getting better as the U.S. pumps more crude oil.
Valero made a major capital spending push from 2008 through
2012, spending $12 billion to modernize and maintain its
refiners. Annual capital expenditures (capex) have since dropped
to around $2 billion, enabling FCF to surge. Valero appears
poised for nearly $3 billion in annual free cash flow in the
years ahead, and as a result, management is expected to continue
to devote roughly $1 billion a year to buybacks, and at least
$500 million towards dividends. Valero has also trimmed long-term
debt roughly $2 billion over the past three years.
Lastly, Total Yield investors should give a close look to
Iconix Brands (Nasdaq:
, which owns a wide range of apparel brands such as Starter,
Danskin, Joe Boxer and Candies. Management has shown a remarkable
knack for squeezing out FCF, which has risen for five straight
years to a recent $231 million. That came on a base of sales of
$432 million, which highlights the powerful economics of the
company's brand licensing model.
Iconix spent more than $400 million on share buybacks last
year, reducing the share count by more than 20%. A fresh buyback
announcement in February should reduce the share count by double
digits again this year.
Risks to Consider:
Companies can get carried away in their pursuit of free cash
flow. If they begin to underinvest in the business, then future
returns may suffer. So it pays to dig into management's
explanation of capital allocation resources, which is often found
in the annual report.
Action to Take -->
The greatest appeal of free cash flow is its transparency. It is
free from the accounting gimmicks that can be used to distort
metrics such as operating margins or earnings per share (
). As such, companies with solid FCF yields -- like H-P, Xerox,
Valero and Iconix -- deserve a strong consideration from
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