Perhaps the most powerfulinvesting angle for our times has
been the ever-rising tide ofcash parked on corporate balance
And the only way to build that cash (besides sellingstock or
key assets) is to generatefree cash flow (which is defined as
operatingcash flow minuscapital spending).
I recently took
of the impressive free cash flow being generated by small-cap
firms. In this column, I look at mid-capstocks in the S&P 400
and bigger companies in the S&P 500. Not only are these firms
prodigious producers of free cash flow, but they look like solid
values as their free cash flow (
) yields (which is free cash flow divided bymarket value ) exceed
10%. Anytime youspot such robust FCF yields, it's time to step up
your research: High yields only last while a stock remains
The double-digit yielders
Less than 3% of all stocks (11 of them to be exact) in the
S&P 400 are able to boast of a double-digit FCFyield . As I
did in my look at small caps, I eliminated any companies that
failed to generate positive free cash flow in each of the past
three years. The remaining four, though, are worth further
research, though in my mind, one stands out as providing
especially compelling value.
Strong Mid-Cap Free Cash Flow Yields
Protective Life (
This financial services firm, which focuses on insurance
products, has developed a steadily profitable business for all
economic climates. Going back six years, through economic upturns
and downturns, its free cash flow has always exceeded $550
More impressive, that robust cash flow has managed to boost
tangiblebook value per share from $9 in 2008 to a recent $58.
That meansshares trade for just 60% of tangible book. (The stock
currently trades at $35, so $35/$58 = 60%.) And with such a
valuation disconnect, Protective Life has wisely been an active
buyer of its own stock, acquiring roughly 5 million shares
(representing 6% of the share count) in the past two years, with
plans to buy back more shares in 2013.
"Management estimates it has the capacity to engage in $500
million in (mergers and acquisitions) without sacrificing the
current $100 million annual pace of share repurchase," according
toanalysts at Merrill Lynch.
Indeed, the company is said to be in talks to acquire the U.S.
assets of French insurer AXA for $1 billion. That may help boost
the company's long-term growth trajectory, but with shares
trading at such a sharp discount to book value, shareholders
would be better rewarded with more aggressive buybacks.
Analysts at UBS disagree, noting that "a potentialacquisition
is the maincatalyst for further materialupside in the stock ...
as Protective Life has considerable expertise in
If the AXA acquisition comes to pass, then management may
choose to hold off on further share buybacks thisyear . By 2014,
however, look for more aggressive efforts to reward shareholders
-- especially if this stock remains so far below tangible book
For that matter, thedividend deserves greater attention.
Though it has steadily risen from 48 cents a share in 2009 to a
recent 70 cents, the
remains below 20%. Looking out several years, this business is
likely to generate more than $1 billion in annual free cash flow,
as was the case in 2008 and 2009, once interest rates moveback up
to historically typical levels.
With $1 billion in free cash flow and a 35% payout ratio, the
dividend would rise to around $4.20 a share, equating to a
12%dividend yield . It may be several years before that scenario
plays out, but patient investors may be handsomely rewarded at
current entry points -- not only from that eventual juicy yield,
but the share priceappreciation that would ensue from this
stock's rising appeal for income investors.
Sticking with insurance
There are four companies in the S&P 500 that sport impressive
double-digit FCF yields, and it's no coincidence that three of
the companies are insurers.
Strong Large-Cap Free Cash Flow Yields
The hard-to-fathom question is why these stocks remain out of
favor in light of their solid financial performance. To be sure,
insurance stocks are not timely -- low interest rates tend to
depress insurers'earnings -- but the fact that free cash flow is
solid implies that the numberswill be far higher when rates
Prudential Financial (
, whose free cash flow has been so robust that book value per
share has risen from $32 in 2008 to a recent $83. Trading at a
recent $55, this stock sports a price/book ratio of just 66%. Due
to some regulatoryissues , Prudential isn't buying back any stock
at the moment, but is expected to resume share buybacks later
this year, and analysts assume that Prudential will have up to
$1.2 billion to work with to buy back shares.
It's notable that
investors are finally responding to the company's remarkable
generation of free cash flow.
But Xerox's recent rebound has room to continue. The company
has generated an average of $1.7 billion in free cash flow in
recent years, yet the company is valued at less than $11 billion.
Analysts at Citigroup expect free cash flow to move above $2
billion in 2013, 2014 and 2015, which should set the stage for
both share buybacks and a dividend boost.
Risks to Consider:
The companies on the tables above have generated meager or
even negativerevenue growth in recent years, and a downturn in
the U.S.economy would make it hard for them to generate a revenue
Action to Take -->
This is an exercise that should apply to many companies in your
portfolio. If a company is largely mature, then it should be
expected to generate solid free cash flow tooffset the mature