Cash cows bring in loads of free cash flow that help them sustain dividends and buybacks – and generate long-term value for investors.
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. (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 tend to be the best dividend stocks, consistently growing their payouts and earnings per share over time. This is partly because through stock buybacks, the denominator, or the shares outstanding, drops over time.
To find the best stocks to buy, we looked for companies that generate impressive free cash flow and put 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.
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