There are several financial metrics that long-term investors need to monitor in the holdings they already have and the ones they are considering. Cash flow matters because it gives companies the financial flexibility to improve the business by paying down debt, making acquisitions, or funding investments. Alternatively, it can return money to investors via share buybacks or dividends.
For example, oil major Chevron (CVX 1.04%), workflow technology specialist Trimble (TRMB -0.50%), and Google owner Alphabet (GOOG -1.96%) (GOOGL -1.97%) are all set to generate a significant amount of cash flow in 2023. Here's why that makes these three attractive stocks to buy.
1. Chevron
There are no prizes for guessing that Chevron's revenue tends to correlate with the price of oil over time, and that's likely to be the case for the foreseeable future.
Data by YCharts
However, there's something different happening this time around in the inevitable up-and-down oil price cycle with Chevron and other oil majors. As you can see in the chart below, in the upcycle of 2010-2015, Chevron (along with many other oil majors) significantly ramped capital expenditures (in absolute terms and as a share of revenue).
Data by YCharts
Of course, this type of behavior often leads to supply gluts when demand turns down, and the 2015-2020 downcycle in the price of oil is evidence of that. That said, faced with a recent history of disappointment and the long-term existentialist threat coming from renewable energy, Chevron has been more constrained in its spending in the current upcycle, leading to significantly increased free cash flow generation.
Data by YCharts
As such, Chevron uses its cash to reduce debt, buy back stock, and gradually increase spending. This means its annual $6.04 per share dividend (up from $4.48 in 2018) gives investors a 3.4% dividend yield, and management recently gave guidance for annual buybacks of $10 billion to $20 billion worth of stock (3% to 6% of the current market cap).
While there's no telling where the price of oil will go, Chevron is well-placed to generate value for investors if oil stays at $60 a barrel and above (West Texas Crude is currently $80.50), starting with the company's cash flow.
2. Trimble
Trimble's roots lie in precise hardware and software positioning technology. Think of geospatial positioning for mapping and surveying, or the precise location of points on construction projects, or monitoring the movement of trucking fleets or agricultural equipment.
However, Trimble's future lies in becoming an increasing part of its customers' workflow by expanding its connected software applications and cloud platform services to customers -- management calls this "connect and scale." The company's software solutions can generate the data to help customers make better modeling and planning decisions in real-time -- think of transportation fleets having routes optimized or the precise management of a construction or infrastructure project.
Image source: Getty Images.
Trimble's agreement to buy transportation management software company Transporeon for 1.88 billion euros is part of its connect and scale strategy.
Trimble's earnings before interest, taxation, depreciation, and amortization (EBITDA) dipped in 2022, and its FCF declined significantly. Still, the latter is largely down to a change in tax legislation that pulls forward payments and an increase in inventories to ensure the delivery of products. Both issues will normalize over time, and Wall Street analysts and Trimble's management expect a substantial increase in FCF in 2023.
The cash flow will help reduce debt following the Transporeon acquisition, and trading on an estimated price-to-FCF multiple of less than 18 times FCF, Trimble looks like a good value.
Data source: Wall Street analyst consensus from marketscreener.com
3. Alphabet
This tech giant attracted attention recently after management told employees it would be initiating cutbacks on expenses, including things like laptops, staplers, and fitness classes, after announcing 12,000 job cuts earlier in the year.
Image source: Getty Images.
The focus on cost-cutting is understandable in a slowing economy, particularly as weak consumer spending negatively impacts advertising spending and Google's search revenue.
That said, Alphabet is hardly in a weak cash position. Wall Street analysts expect Alphabet to end the year with $122 billion in net cash after generating $70.5 billion in FCF. That figure would put Alphabet on a forward price-to-FCF multiple of just 19 times FCF.
As such, the key question for investors is not how Alphabet can cut costs (although necessary) but how management will generate value for shareholders by investing its vast cash flows. That's what the company should focus on because it's why investors put money into a company: It should do a better job generating returns than investors could do themselves.
It's a critical issue, and if Alphabet's management doesn't find a way, the pressure will only build for the company to pay a dividend. The good news is the company has ample financial flexibility to explore all options, and the stock trades at an attractive valuation.
