One of the best strategies for finding rewarding stocks for the long term is to focus on how well a company generates free cash flow. Earnings per share is the most widely touted profit metric, which gets all the headlines when companies report quarterly results. But, as they say, cash is king.
Companies that generate lots of cash can reward shareholders with dividends, share repurchases, reinvest for growth, or make a game-changing acquisition that enhances the company's value to investors.
With that said, Apple (AAPL +2.66%), Amazon.com (AMZN +0.61%), and PayPal Holdings (PYPL 7.75%) are three companies that do a phenomenal job of churning out healthy amounts of free cash flow, which is why these stocks could be excellent choices for your portfolio.
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1. Apple
Apple is one of the great brands of our time. Through careful attention to detail and design, Apple turned a commodity product (computer hardware) into something that millions of people will gladly pay a premium for compared to competing manufacturers. It's no wonder that Warren Buffett's Berkshire Hathaway owns 5% of the Mac maker.
Apple sells tens of millions of devices every quarter, which are all priced to earn a healthy profit margin. Although iPhone sales are not growing like they used to, Apple now has a large and growing installed base of 1.4 billion active devices which is a built-in market for sales of services, such as apps and subscriptions, which should only enhance Apple's margin profile over the long term.
The iPhone maker is a veritable cash cow, with $210 billion in cash and investments on the balance sheet, and $58 billion generated in free cash flow over the last year. Management has stated that they want to bring the cash balance down to optimize the company's capital structure better, but that means investors will reap the rewards through more dividends and share repurchases.
2. Amazon.com
The online retail giant needs no introduction. The growth of Amazon will likely be studied in business schools just as students learn about how Sam Walton conquered the brick-and-mortar retail world with his discount stores in Arkansas. What started as a tiny online commerce operation partly financed by Jeff Bezos' parents' life savings is now an international juggernaut with $252 billion in annual net sales and is involved in business segments that not even Bezos could have imagined 20 years ago, such as cloud computing, robotics, advertising, healthcare, and who knows what else.
Amazon Prime Day is now a bigger shopping day for the company than Black Friday and Cyber Monday combined. Roughly 30% of the U.S. population has a Prime membership. With Amazon moving to one-day delivery -- consistent with management's relentless focus on pleasing the customer -- there are likely millions of more people in the U.S. alone that will eventually succumb to the temptation never to leave their house to buy anything.
For many years, Amazon got a bad rap for its lack of profitability. It was difficult for investors to wrap their mind around the idea that Amazon could be a good investment without reporting a profit. However, Jeff Bezos & Co. have always prioritized making decisions internally that maximize free cash flow instead of net income. Cash is the lifeblood of any business, and Amazon has fueled its growth over the years with its focus on generating as much cash as possible.
Over the last year, Amazon generated $25 billion in free cash flow, which has gotten a huge boost from the fast growth of Amazon Web Services, which generated most of the company's profit in the second quarter.
3. PayPal
PayPal is at the forefront of the mobile payment tidal wave sweeping across the world right now. The company's reputation for delivering secure online transactions and convenience has continued to draw in millions of new customers. The customer account total stood at 286 million in the most recent quarter, which has been growing lately at a steady clip of 15% to 17% year over year.
The growth in the customer base is fueling rapid growth in PayPal's scale. It processed $640 billion in payment volume over the last year, and this is likely only a fraction of where PayPal will be in the next few decades.
PayPal sold its credit receivables and loan portfolio to Synchrony Financial to free up cash so that it can invest to expand PayPal's ubiquity and capabilities. PayPal now has $10.7 billion in cash and investments and generated $3.5 billion of adjusted free cash flow over the last year. Management plans to spend about $1 billion to $3 billion in acquisitions each year, and the company is also signing new deals to partner with leading e-commerce platforms, most recently with Uber Technologies and MercadoLibre.
After reading about Amazon and Apple, $3.5 billion of free cash flow doesn't sound like much, but consider that PayPal's free cash increased by 40% year over year in the last quarter.
Looking at it another way, PayPal's free cash flow made up 21% of trailing-12-month revenue. At the rate the company is growing, it's likely PayPal will generate well above $10 billion in annual free cash flow within the next decade.
