One of the primary metrics that many investors consider when evaluating a company and its stock is its cash position. How much cash does it have on hand, and how much free cash flow does it generate?
Generally speaking, the more cash a company has coming in, the more it will have available to pay down debt, invest in its growth, and maintain and increase its dividend payouts.
Consider, for example, Visa (V 0.25%)Visa has been one of the best and most consistent growth stocks on the market with an average annual return of about 26% over the past 10 years. It's also a growth stock that happens to pay out a dividend. While its dividend has a lower-than-average yield, Visa has raised its annual payout for 12 straight years and has plenty of cash to comfortably continue making raises.
Let's take a closer look at how Visa's cash position help make it a great growth stock that has been able to increase its dividend payouts.
Visa has lots of cash
Visa is the largest credit card and payment processor in the world, and one of just two major players in its space along with Mastercard. While other companies like American Express and Discover also process credit card transactions, they follow a different business model in that they also lend the money to creditors. Visa and Mastercard don't, so they take on little to no credit risk -- they just collect fees for processing payments on their vast networks. Every time someone makes a purchase with a Visa-branded credit card, Visa extracts a fee, which becomes revenue. The business model also creates a situation of relatively low overhead and expenses, which leads to huge margins and lots of cash flow.
Its operating margin -- the share of its revenue left over after it covers all the expenses associated with facilitating sales transactions -- is 65%. An operating margin of 15% to 20% is considered really good in a lot of business sectors, so 65% is off the charts. Visa's operating margin is also the highest among its payment processing peers.
Visa currently has $18 billion in cash and cash equivalents on the books, with about $13.3 billion in operating cash flow and $12.6 billion in free cash flow annually. (Operating cash flow is the amount of money that flows into the business as a result of normal operating activities, while free cash flow is the excess cash it has left after it covers its operational expenses.) All of these metrics have steadily gone up over the past 10 years.
Now let's look at the other side of the balance sheet -- debt.
Visa has manageable debt
Cash is the lifeblood of any company. It lets you invest, weather downturns, and pay down debt, among other things. Visa, as of June 30, had about $21 billion in long-term debt. Is that manageable, given its capital strength? There are a couple of ways to measure that.
One is the current ratio, a metric meant to gauge how well a company can manage its short-term liabilities. A current ratio under 1 means a company's liabilities are greater than its assets, so that's not good. Visa has a current ratio of 2, which means it can pay short-term liabilities two times over. That's a good number. Indeed, a number much higher than 2 on this metric may reflect that the company in question is hoarding cash too much rather than investing in growth.
Another metric to watch is the debt-to-equity ratio -- total liabilities divided by shareholder equity. It can tell you how much a company is financing its operations through debt. A high debt-to-equity ratio -- say, anything over 2 -- suggests a company may be making too much use of debt to finance its growth efforts. A ratio under 1 -- which reflects a company using less debt and more of its own funds to finance operations -- is ideal. Visa's debt-to-equity ratio is an excellent 0.5.
In sum, Visa has a lot of cash and a manageable level of debt. That combination has been one big reason it has been able to post an average annual return of about 26% over the past 10 years. But it's also a good bet for income investors.
As mentioned, Visa has increased its dividend for the last 12 years and its quarterly dividend has grown by more than 1,100% since 2009. It offers a quarterly payout of $0.32 per share ($1.28 per share annually), which at current share prices yields 0.55%. Its yield is so low mostly because Visa's share prices have risen by about 975% over the past decade. Visa's payout ratio is about 22%. As dividend stocks go that is a very manageable ratio. Income investors will appreciate that Visa is not stretching to pay its dividend, and it has plenty of capacity to keep boosting it for years to come.
This all adds up to a great investment, whether you're looking for dividend income, capital appreciation, or maybe a stock that offers both.