Investors love cash cows – companies that generate consistent free cash flow. FCF, as it is often abbreviated, is what is left over or “free” from operating cash flow after deducting capex payments and working capital requirements. These stocks tend to do well over time.
This is because firms with high FCF margins (i.e., free cash flow as a percentage of sales) can afford to make dividend payments and acquisitions, buy back stock, reduce debt, or just let the cash pile up on the balance sheet.
The average operating profit margin for the S&P 500 was 12.7% in 2022, according to Yardeni Research (opens in new tab). (Operating margins are typically higher than FCF margins as they don’t include capex and working capital expenses as do FCF margins.) So generally, any company with a 20% or greater FCF margin can be considered a cash cow.
What’s more, these stocks can grow their dividends and earnings per share over time. This is partly because through stock buybacks, the denominator, or the shares outstanding, drops over time.
With this in mind, here are six of the best cash cows to buy now. Each stock featured here generates impressive free cash flow and puts it to good use via dividends, buybacks and more. Plus, each has a high FCF margin and yield, which indicates it will do well over the long term.
Data is as of April 3. FCF margins are calculated by dividing a company’s last 12 months (LTM) free cash flow by its TTM sales. FCF yield is the last 12 months free cash flow divided by the market value of the stock.
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Alphabet Market value: $1.3 trillionLTM FCF margin: 21.2%LTM FCF yield: 4.5%Alphabet (GOOGL (opens in new tab), $104.36) is one of Wall Street’s top cash cows because it brings in large amounts of free cash flow. This search engine and cloud software giant generated $60 billion in FCF in the last 12 months. Given its LTM sales of $282.8 billion, this puts its FCF margin at 21.2%. Generally, any company with a FCF margin over 20% is considered higher than average.
While advertising revenue based on search declined in the last quarter, the company’s Google Cloud has been more than making up it. For example, in Q4, the 32% revenue growth in Google Cloud led to an average of 1% growth in revenue overall.
And this is what is helping Google’s FCF stay strong. Moreover, the company is addressing potential cash flow issues, including with its decision to lay off 12,000 people, or 6% of its global workforce.
Nevertheless, Alphabet is putting its FCF to good use to help shareholders. Although it does not pay dividends, it spent $59.3 billion on stock buybacks. This represents nearly all of its $60 billion in FCF over the past year.
Moreover, it means that about 7.85% of its publicly traded stock was retired last year through buybacks of 530 million shares, including 469 Class C shares, based on its 10-K filing. That suggests that earnings per share could rise by almost 8% even if net income stays the same. It also means that shareholders have a bigger stake in the company. This is why cash cows like GOOGL are worth buying.
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Palo Alto Networks Market value: $60.4 billionLTM FCF margin: 43.7%LTM FCF yield: 4.5%Palo Alto Networks (PANW (opens in new tab), $196.33) is a cybersecurity software company that generated $2.7 billion in free cash flow over the 12 months ended Jan. 31. This is based on comments from the company’s chief financial officer during PANW’s earnings call (opens in new tab) on Feb. 21. Since Palo Alto Networks also produced $6.2 billion in LTM revenue, its FCF works out to 43.7% of its sales. This 43.7% FCF margin easily makes it a very prosperous cash cow.
Moreover, since PANW stock has a market capitalization of $60.4 billion, its FCF yield is 4.5%. So, here we have the best of both worlds, a cash cow and a low valuation.
Palo Alto Networks has been around since 2005, which is a long time in software years. Moreover, its sales are up nearly 90% since fiscal 2019, showing that its products are relevant to companies that need software security products and services from them.
However, although Palo Alto Networks does not pay a dividend, it has been aggressively buying back its stock. For example, in the last year, it repurchased $652 million of its shares, and after net of stock issuance, this was $506 million. That is just under 1% of its stock market capitalization. But it still means that $2.2 billion was left over from the $2.7 billion in FCF.
So, what has Palo Alto Networks been doing with its excess FCF, after its buybacks?
It’s piling the cash up. It turns out this top cybersecurity stock is a defensive company that is simply storing its cash by buying long-term investments. In the last year, long-term investments have risen by almost $2 billion, from $851 million to $2.8 billion as of Jan. 31. That accounts for most of the excess FCF and shows that Palo Alto Networks is a cash cow.
In total, PANW now has $6.2 billion in cash and investments, or 10.7% of its stock market valuation. At this pace, in four years, the cash could be worth almost 31% of its market capitalization.
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Broadcom Market value: $267.9 billionLTM FCF margin: 48.9%LTM FCF yield: 6.3%Broadcom (AVGO (opens in new tab), $642.47) is a semiconductor manufacturer with a diversified client base that includes Apple (AAPL (opens in new tab)) and its smartphones. It also serves markets such as networking and cloud. In addition, AVGO is looking to close on its $60 billion acquisition of VMware (VMW (opens in new tab)), a software and cloud management company, though the deal is facing regulatory scrutiny.
In the last 12 months ending Jan. 29, Broadcom generated over $16.8 billion in free cash flow. Comparing that to its LTM revenue of $34.4 billion shows that its FCF margin is an amazing 48.9%. That makes it one of the best cash cows in the S&P 500. In fact, in the company’s latest quarter, its FCF rose 16% year-over-year.
Moreover, AVGO stock is still cheap. Given that its market cap is roughly $268 billion, this means its FCF yield is high at 6.3% (i.e., $16.8 billion/$267.9 billion).
So, here we have an amazing cash cow company that has a cheap valuation with a 6.3% FCF yield – again the best of both worlds.
Of course, the market is still waiting for the VMware acquisition to close. Broadcom says it expects to close the deal sometime in its fiscal year ending in January 2024.
In the meantime, shareholders are happy to receive the company’s $18.40 per-share annual dividend, which is up 12% over last year. More importantly it gives AVGO stock a 2.9% yield – pretty impressive for a tech stock. Broadcom uses its $18 billion in FCF to cover the annual cost of the dividend which is about $7.7 billion.
Moreover, it is spending $4.7 annually on share buybacks on top of $1.3 billion for share awards. In addition, the company is focusing about $1 billion toward debt reduction. All of these are uses of its abundant FCF and show that the company is clearly working on behalf of its shareholders.
All in all, Broadcom is one of the best cash-cow and high FCF-yield stocks in the S&P 500.
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Altria Group Market value: $80.3 billionLTM FCF margin: 38.9%LTM FCF yield: 10.0%Altria Group (MO (opens in new tab), $44.98) sells smokable and oral tobacco products. Of course, its Marlboro brand is iconic throughout the world. This is a hold-your-nose kind of stock, especially if you think its products do nothing to help humanity. And it probably doesn’t fit into ESG-sensitive portfolios.
Nevertheless, it is a massive cash cow and as such we simply can’t ignore it, especially for anti-ESG investors, or those who simply don’t care about ESG. For example, Altria’s LTM free cash flow was $8.05 billion on $20.7 billion in sales in 2022. That puts its FCF margin at a whopping 38.9% for the year.
Moreover, MO stock is cheap despite its cash cow status. If we divide the LTM FCF of $8 billion by its market cap of $80 billion, the FCF yield is 10.0%. That is the highest FCF yield of all the cash cow stocks featured here.
Altria is using that FCF for shareholders. It presently has a $1 billion share repurchase authorization and has been spending between $1.8 billion and $2 billion annually on stock buybacks.
In addition, its annual dividend cost $6.6 billion based on its annual rate of $3.76 per share. That gives the stock an ample dividend yield of 8.5%.
As a result, investors can expect that $8 billion in free cash flow is used up by at least $1 billion to $2 billion in buybacks, and $6.6 billion in dividend payments.
Given that MO stock trades at just 14.1 times earnings this year and 9 times next year’s earnings, it is very inexpensively priced. Along with its 10.5% FCF yield, MO stock is one of the cheapest cash cows to buy right now.
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Microsoft Market value: $2.1 trillionLTM FCF margin: 29.2%LTM FCF yield: 2.9%Microsoft (MSFT (opens in new tab), $287.23) is a major software company that operates in every key area of the software industry: operating systems, cloud, gaming, application software, and now even artificial intelligence (AI) with its new Bing chatbot.
MSFT’s powerful free cash flow of $59.6 billion over the last 12 months was more than sufficient to cover its dividends, share repurchases, acquisitions and debt reduction. Moreover, it represents 29.2% of its $204.1 billion in revenue over the past year. That clearly puts it in cash cow status, as this is well over 20%.
In addition, compared to its market capitalization of $2.1 trillion, the roughly $60 billion in LTM FCF represents a 2.9% FCF yield. That makes it relatively cheap and one of the best cash cows to buy.
In addition, Microsoft is using its FCF to cover its dividend and buybacks. It pays a $2.72 per-share annual dividend, up 9.7% over last year. The $60 billion in FCF more than covers the $19 billion annual dividend cost as well as $28.6 billion the company spent on share buybacks.
Microsoft’s Office, LinkedIn and cloud services products (Productivity and Business Processes division) enjoy strong appeal with consumers (up 7% in the latest quarter). In addition, its other revenue in Intelligent Cloud grew 18% in the last quarter.
Moreover, the Dow stock is not that expensive at just 31.9 times earnings forecast for the year ending June 2023, and 26 times for June 2024. Both figures are below the company’s five-year averages.
Given its cash cow status and high FCF yield, investors might expect that MSFT stock will continue to do well.
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Paychex Market value: $41.3 billionLTM FCF margin: 30.5%LTM FCF yield: 3.6%Paychex (PAYX (opens in new tab), $111.33) is a human resources, payroll, benefits and insurance services company for small to medium-sized businesses in the United States, Europe and India.
The company reported stellar earnings and cash flow on March 29 for its fiscal third quarter ending Feb. 28. Its operating cash flow for the previous nine months was $1.29 billion, which implies its Q3 operating cash flow was up 88% in the quarter. Moreover, in the last 12 months ending Feb. 28, its FCF was $1.5 billion on sales of $4.9 billion. That gives it a massive FCF margin of 30.5%. That makes Paychex a legitimate cash cow.
And given that its market capitalization is just $41.3 billion, this gives it a high FCF yield of 3.6% (i.e., $1.5 billion / $41.3 billion).
Analysts expect the company to show earnings of $4.27 per share this year ending May 31 and $4.58 per share next year. That means at today’s price, PAYX stock is moderately expensive at 24.1 times forward earnings, though this is still below the company’s five-year average.
The bottom line is that small and medium businesses continue to grow and need HR and the kind of payroll services that Paychex offers its clients.
PAYX pays a $3.16 per-share annual dividend, which costs the company about $1.1 billion of the $1.5 billion in LTM FCF. That gives PAYX stock a 2.8% dividend yield based on its current price. In addition, Paychex has been spending $145 billion annually on share buybacks.
Given its solid revenue growth, operating margins, free cash flow, dividends and buybacks, Paycheck stock looks like one of the best cash cows to buy now.
Sponsored Content (opens in new tab) Mark R. Hake, CFA, is a Chartered Financial Analyst and entrepreneur. He has been writing on stocks for over six years and has also owned his own investment management and research firms focused on U.S. and international value stocks, for over 10 years. In addition, he worked on the buy side for investment firms, hedge funds, and investment divisions of insurance companies for the past 36 years. Lately, he is also working as Chief Strategy Officer for a tech start-up company, Foldstar Inc, based in Princeton, New Jersey.