Free cash flow -- or owner earnings, as it is referred to by the legendary investor Warren Buffett -- represents the cash available to shareholders after all other claims have been met. Based on FCF, a good measure of the fundamental strength of a company is its FCF yield, which is calculated by dividing a company's FCF per share by its current market price per share. A positive FCF yield means the company earns more cash than is needed for operations, which then can be used to fund growth, innovate, decrease debt, pay and grow dividends, or fund share buybacks.
While past performance may not necessarily replicate in the future, a few growth stocks with dividend yields exceeding 2% currently appear undervalued by their FCF. Here is a closer look at three dividend stocks with FCF yields at or above 6.7% and showing sign of future growth.
The 3 musketeers
Owens & Minor (OMI 5.53%), a provider of health care products and third-party logistics and supply chain management services, has a FCF yield of 8.94%. The company has paid dividends since 1926, and has increased them for the past 16 years in a row. Currently, it has a dividend yield of 2.7%, a payout ratio of nearly 40% of last year's FCF, and a five-year annualized dividend growth rate of 13.7%. When a company has a long-term track record of consistent and rising dividend payments, it is a clear indicator that the company's financial position is good. For the fifth year in a row, it was named the sole winner of the 2013 Premier Polaris Award by the Premier health care alliance, which recognizes supplier performance that goes beyond excellence in contract compliance to high relationship value and exceptional customer service.
For 2013, the company is targeting revenue growth of 2% to 4% and adjusted net income per diluted share of $1.90 to $2.00 for the year, which excludes acquisition-related and exit and realignment costs. Late last year, Owens acquired Movianto, one of Europe's leading third-party health care logistics companies. The segment is likely to see losses over the interim due to an unstable European economy, but I also believe investors are not seeing the forest for the trees. This stock is a safe play that will suit the needs of conservative investors looking for a healthy, dividend stock.
Marvell Technology Group (MRVL 1.56%) is a chipmaker with a FCF yield of 7.08%. The company is one of the largest holdings in David Einhorn's Green Light Capital Hedge fund as well. Einhorn boosted his Marvell stake when the company's shares plunged after a ruling by a U.S. judge that imposed a $1.1 billion fine on Marvell, due to its infringement of two patents held by Carnegie Mellon University.
Aside from this, Marvell still has a strong growth outlook, as its product pipeline is increasingly focused on the storage and smartphone markets. Specifically, Marvell's wireless connectivity business should continue to grow, supporting a profit recovery over the back half of this year. It is introducing numerous products for growth product markets such as tablets, ultrabooks, gaming, and video. As Marvell continues to develop proprietary technologies, it is expected to realize better gross profits, perhaps better than the industry as a whole and is an excellent option for dividend investors to consider.
Quest Diagnostics (DGX 5.08%) -- the world's leading provider of diagnostic testing, information, and services -- has a FCF yield of 8.61%. Quest has embarked on a robust dividend growth since 2011, increasing its regular dividend cumulatively by 200%. The outlook for continued dividend growth is strong, as the company boasts a low payout ratio of only 21%. Its current yield is 2%.
DGX is focused on restoring growth, targeting low-single-digit revenue growth through 2015. Still, its revenues will be mainly flat this year, approximating revenue growth in the previous year. With the U.S. instituting measures designed to reduce its federal deficit, and much of Europe in a similar situation, diagnostic device makers have struggled to improve their top and bottom lines in recent quarters. Priced at 18 times earnings, but only 11 times free cash flow, Quest shares are bargain-priced for analyst expectations of 12% annualized earnings growth over the next five years. Throw in the 2% dividend yield, and the stock's undervaluation only becomes more apparent. Considering that the baby boomer population is aging and diagnostic equipment is becoming faster, more accurate, and more affordable, the future growth of Quest looks promising and is set up nicely for the aging demographic in the coming years.
Foolish final thoughts
Research suggests that stocks boasting high FCF yields have historically outperformed the stocks with low FCF yields, as well as the broader market. Moreover, stocks combining the highest FCF yields and the highest dividend yields have produced the highest total returns. The aforementioned stocks are all solid companies showing signs of future growth and excellent options dividend investors should consider.
