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Earning a Great Return on Your Stocks

These companies have generated high cash returns and earnings yields.

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Investors often think of stocks and bonds as completely different animals. And, of course, the two types of securities play very different roles in a portfolio: Investors generally look to bonds to generate income and temper risk, while stocks are meant for long-term growth. But looking at stock valuations through a fixed-income perspective can be a useful way to make sure you're really earning what you should from your stock investments.

For this week's Five-Star Investor, we used Morningstar's  Premium Stock Screener to find companies with cash returns greater than the yield on the 10-year Treasury bond, which was holding steady at about 4.3% at the time of this writing. Cash return looks at a company's free cash flow as a percentage of its total enterprise value, or market capitalization plus debt. In other words, it measures the return a hypothetical buyer would earn by buying out the entire company (debt and equity) and skimming off the excess cash. About one fourth of the roughly 6,500 companies in Morningstar's equity database passed the first hurdle.

Next, we focused on earnings yield, which looks at a company's earnings divided by the stock price (the inverse of the price/earnings ratio). Like cash returns, earnings yield can be used to compare a stock's return with the yield offered by bonds. To find stocks with earnings yields of at least 4.3%, we first converted that figure back into an equivalent price/earnings ratio of 23.2, and looked for stocks with current price/earnings ratios below that level.

Finally, we wanted to weed out companies with erratic financial performance, so we limited the group to companies with consistent growth in free cash flows over the past three years.

Here are some of the stocks that made the final cut:

 Automatic Data Processing (ADP)
Cash Return: 6.65%
Morningstar Rating: 4 Stars
From the  Analyst Report: "ADP has significant competitive advantages in each of its main businesses, and barriers to entry are high. It should remain a cash-generating machine for years to come."

 McGraw-Hill Companies  (MHP)
Cash Return: 9.32%
Morningstar Rating: 4 Stars
From the  Analyst Report: "We believe that McGraw-Hill's businesses are very attractive, and we'd be buyers as long as we could get in at a 20% discount to our fair value estimate."

 Cedar Fair LP (FUN)
Cash Return: 4.65%
Morningstar Rating: 3 Stars
From the  Analyst Report: "Cedar Fair has a long history of generating fat profits. Free cash flow as a percentage of sales has averaged 15% over the past decade, and operating margins are 60% higher than those of Six Flags PKS."

 Laboratory Corporation of America (LH)
Cash Return: 7.66%
Morningstar Rating: 3 Stars
From the  Analyst Report: "LabCorp is one of two major independent diagnostics-service providers left standing after intense industry consolidation in recent years. We think it has taken better advantage of its position than market leader Quest Diagnostics DGX has, and we'd consider the shares if they traded at a 40% discount to our fair value estimate."

To run this screen yourself and see all the stocks that passed, click  here. (The stocks mentioned above passed our screen as of Oct. 9. The results of the screen may change due to daily price fluctuations or other factors.) After clicking, you can save the search to use later by clicking the "Save Criteria" button in the bottom right-hand corner of the screen. (Note: You will need to be a Premium Member to view and save the complete screen.)

Amy C. Arnott does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.