4 Free Cash Flow Kings That Really Look After Their Shareholders

In business, cash is king and the companies with the best cash flows are often the ones that are able to achieve the best returns for their investors. Unsurprisingly, the list of the most cash-generative companies in the world is dominated by big tobacco and big pharma.

In particular, the list is topped by Philip Morris International (NYSE: PM  ) , followed closely by Pfizer (NYSE: PFE  ) and Johnson & Johnson (NYSE: JNJ  ) . McDonald's (NYSE: MCD  ) also sits in the top 10. All of these companies convert more than 15% of their sales into free cash flow; an impressive metric.

Why is this important?
According to Investopedia, free cash flow as a percentage of sales can indicate the "real" amount of cash that the company earns. Indeed, free cash flow is a metric that is much harder to distort with accounting gimmicks and window dressing, methods that are often used to manipulate earnings. In the simplest possible terms, the free cash flow as a percentage of revenue figure is a measure of how much of a company's revenue is transformed into cash.

Revealing figures
So, what percentage of revenue do these industry behemoths listed above convert into free cash flow? Well, Philip Morris, as previously mentioned, tops the list. In the period between 2008 and the third quarter of 2013, the company converted 29.1% of its revenue into free cash flow. During the same period, Pfizer converted 26.4% of its revenue into free cash flow. Johnson & Johnson converted 20.2% of revenue into free cash flow, and McDonald's converted 16%.

It's easy to see how these impressive free cash flow metrics impact shareholders. Indeed, during the five-year period of 2008 to Nov. 15, 2013, McDonald's increased its dividend payout to investors by 116%. Meanwhile, Philip Morris increased its payout 104.3%, and Johnson & Johnson increased its payout 43.5%. All of these payout increases were far above inflation, which is usually considered the benchmark for dividend growth.

Unfortunately, during this period, according to my data, Pfizer's payout dropped by 25%, but the company has ramped up share repurchases to compensate. In particular, since the end of 2010, Pfizer has returned $44.4 billion to investors through both buybacks and dividends; that's approximately 150% of free cash flow after dividends.

Of course, all these numbers, although impressive, do not reveal the true story. What investors like me and you really want to know is how much money do we get, and will it continue?

Show me the money
To find out how much cash is actually returned to investors, I'm going to crunch the numbers for the last four quarters of available date to try and figure out how much cash is being returned to investors as a percentage of the share price; and secondly, how well these returns are covered by cash flow to establish whether or not they can continue.

Company

McDonald's

Philip Morris

Pfizer

Johnson & Johnson

Buybacks

$1

$7

$15

$7.2

Dividends

$3

$6

$7

$0.1

Total returned

$4

$12

$22

$7

Cash generated from operations

$7.3

$10.1

$20

$18

Dollar value retuned per share

$4.5

$7.3

$2.7

$2.6

Figures taken over a trailing-12-month period from the third quarter of 2012 to Q3 2013. Source: Marketwatch.com. Figures in billions except per-share amounts. Figures rounded to the nearest billion.

So, for the figures above we can see that McDonald's returned a total of $4 billion to investors during the last four quarters, easily covered by the company's $7.3 billion in cash generated from operations. The same is true for Johnson & Johnson. However, both Pfizer and Philip Morris have returned, in aggregate, $2 billion more to investors over the last four quarters than they have generated from operations.

Foolish summary
So all in all, not only is cash conversion as a percentage of revenue an important metric to asses business profitability, but it is also helpful in determining how much cash investors will receive from the business.

Philip Morris, Johnson & Johnson, McDonald's, and Pfizer are all cash flow kings with some of the best cash-conversion ratios in the business. Each of these four companies generates healthy free cash flow, most of which is returned to investors, and it would appear that this is set to continue.

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