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Cash-Flow Titans with Dividends

These companies turn their free cash flow into shareholder dividends.

If cash is king, which companies wear the crowns?

To find out, I used Morningstar's  Premium Stock Selectorto isolate companies with the strongest 10-year records of generating free cash flow, as well as a record of using that cash to pay (and increase) their dividends. 

Free cash flow is the cash a company generates from its operations, minus the amount it invests in the business. Microsoft's (MSFT) operations, for example, generated $14.5 billion in cash flow last year. The company plowed about $1 billion of that back into the business (capital spending), leaving more than $13 billion in free cash flow--an incredible sum. Only Ford Motor (F) generated more free cash flow last year. Microsoft can use this free cash flow to either pay dividends (as it just announced it will), buy back stock, reduce debt, make acquisitions, or swell its bank account. Mostly, it does the latter.

I set up a search in Premium Stock Selector to find companies that have produced positive free cash flow in each of the last 10 years--a high hurdle. Some firms don't generate much cash from operations. Others have high capital-spending needs. Neither group consistently generates positive free cash flow. Only 668 firms out of the 7,000 in our database pass this criterion.

Next, I narrowed the list to just those firms able to generate free cash flow equal to at least 5% of sales. In other words, for each $1 in annual sales, these companies throw off at least $0.05 in free cash flow. Microsoft, for example, is off the charts in this regard, generating $0.40 in free cash flow for every dollar in sales. Also outstanding are big drug companies like Merck (MRK) and Johnson & Johnson (JNJ). I also require a company to have a return on equity (net income as a percentage of shareholders' equity) of at least 20% over the trailing 12 months. This eliminates firms that have stumbled badly of late, such as McDonald's (MCD).

Finally, I require companies to have paid dividends over the past five years, and to have increased their dividend payouts over that time. 

Thirty-nine stocks pass the screen. To see all the names with one click, you can  run this screen yourself. Once in Premium Stock Selector, you might also want to save the screen so you can run it periodically. The names on the list won't change often, but their valuations will, so it's a convenient watch list of great cash-flow generators. 

To pass the screen, a company must have a first-class record, but how many of these great companies are cheap right now?

Well, five 5-star stocks make the cut, including McGraw-Hill (MHP), Paychex (PAYX), and Automatic Data Processing (ADP). As a refresher, a 5-star rating means we think a stock is currently undervalued by a significant margin. Also, several stocks with attractively high dividend yields pass the screen. Among those rated at least 3 stars areBristol-Myers Squibb (BMY), Clorox (CLX), Dow Jones & Company , and  Merck (MRK)

If you use the link provided above to run the screen, you can then save the criteria. That way, you can run the screen in the future to see what great dividend-paying companies are cheap at any given time. 

Happy hunting!


Haywood Kelly, CFA has a position in the following securities mentioned above: JNJ. Find out about Morningstar’s editorial policies.