When it comes down to it, a company's worth only as much money as it can generate at the end of the day. While millions of accountants pore over financial statements to figure out the best definition of true profit, you eventually just have to look at the dollars and cents and see where they come from and where they end up.
For the most successful companies, generating cash is second nature. Strong, mature businesses almost run themselves, with loyal customers coming back again and again to buy products and services from industry leaders. With the right management, these companies are goldmines for investors, who can simply sit back and watch the money flow in.
That's why today, I've decided to take a look at the stocks in the Dow Jones Industrials (INDEX: ^DJI ) to figure out which ones are best at generating cold hard cash for their investors. Today I'll reveal the five Dow stocks that have the highest amounts of free cash flow. But first, let's look at why free cash flow is a superior metric of success than earnings.
Show me the (real) money
The problem with accounting-based GAAP earnings is that they don't always reflect reality. Arcane rules to figure out complicated situations may succeed in allowing fairer comparisons across companies, but they don't always give a realistic picture of what's really going on behind the scenes. That's one reason so many companies present adjusted earnings figures, in order to make their case that "true" earnings go beyond what accountants prefer to see.
But a better solution is simply to ignore it entirely. Operating cash flow takes away many of the artificial accounting conventions that go into earnings, while subtracting capital expenditures tells you how much cash is left free for other purposes, such as dividends, stock buybacks, or reinvestment into non-capex expenses of the business.
The one drawback is that they don't work well with financial companies. But setting financials aside is a small price to pay for clarity with the rest of the Dow.
The cash kings of the Dow
So with all that in mind, here are the five Dow stocks outside the financial sector with the highest free-cash flow levels over the past year:
Operating Cash Flow
Free Cash Flow
|ExxonMobil (NYSE: XOM )
|Pfizer (NYSE: PFE )
|General Electric (NYSE: GE )
|Chevron (NYSE: CVX )
Source: S&P Capital IQ. As of Jan. 12. Numbers in billions. Rounding may affect results.
Perhaps the most interesting thing about these numbers is to separate these top companies into two categories. On one hand, Big Oil stocks Exxon and Chevron and industrial giant GE have to spend quite a bit of money in capital expenditures to keep their businesses afloat. Whether you're talking about refineries, pipelines, and drilling operations for energy companies or industrial plants and equipment for GE, year in and year out, these old-economy companies push more money back into their businesses to maintain their internal infrastructure, making investments that they see as paying off in the long run.
On the other hand, tech giant Microsoft and Big Pharma stock Pfizer come from a different breed. For them, research and development are the true "capital" expenditures, even though they show up in different places on the balance sheet. As hokey as it sounds, Microsoft's true investment is in the human capital that comes up with new products and perpetuates its legacy platforms. Pfizer's researchers are behind the blockbuster drugs that bring in billions. Next to those investments, things like manufacturing plants and laboratory construction are inconsequential -- and that shows up in their cash flows.
Neither category is inherently "better" than the other, and both clearly bring investors a lot of money. But by being aware of the distinctions between these two types of companies, you'll be in a better position to understand where their money's coming from -- and what might make it stop.
Take the money and run
Of course, even cash kings can lose their thrones in time. Examples like Eastman Kodak prove that yesterday's powerhouse businesses can become tomorrow's has-beens. But for companies with lasting competitive advantages, strong cash flow is definitely a healthy sign.
Another healthy sign for a company is a big dividend. The Dow is notorious for its dividend payers, but some of the best dividend stocks aren't even in the Dow. Let me invite you to join the thousands who've read the Fool's new free report that reveals 11 rock-solid dividend stocks for your portfolio. Don't wait, though -- it's available for only a limited time, so read it today.