Image source: Flickr user Zack McCarthy.
There are few ways to describe the start of 2016 for investors more aptly than "Yuck!" The first two weeks of the year marked the worst start in the markets' recorded history, and the subsequent three weeks haven't offered any improvement.
Using free cash flow to your advantage
So what's an investor to do? One of the smartest moves that can be considered is picking out high-quality, established businesses that are capable of generating significant cash flow regardless of whether or not the U.S. economy is slowing. But a company's perceived value also should be taken into consideration. Just because a company is generating cash flow doesn't mean that investors are going to be willing to chase a P/E of 50 in a volatile, falling market.
It was this thinking that prompted me to run a relatively simple stock screen that aimed to find companies trading at a substantial discount to the forward P/E of the S&P 500 -- in this instance a forward P/E under 10 -- and which offered substantial free cash flow generation -- arbitrarily I chose an average of $4 billion per year. Lastly, the overall dynamics of each company was taken into consideration -- i.e., if this a company that could outperform even during a recession.
Why focus on FCF? So many good things can come from strong FCF generation. There's more money to boost dividends, buy back shares of common stock, boost wages to keep top talent, and fund earnings accretive acquisitions.
Image source: Pixabay.
Seven single-digit stocks with serious free cash flow generation
The results of the stock screen above? How about seven single-digit P/E stocks that collectively could generate $600 billion in free cash flow, or FCF, by 2020.
1. Apple
There is no discussion about FCF without technology kingpin Apple (AAPL +0.26%), which wound up clearing nearly $70 billion in FCF in 2015. Apple has been helped by the introduction of the iPhone 6s, as well as consumers' seemingly insatiable appetite for all things Apple.
But Apple is transitioning beyond just a products company and becoming more of a platforms play. Apple Pay, the company's relatively new mobile-payment platform that offers improved financial protection, its Watch, which combines wearable technology with fashion, and even its experimental Apple Car, expands its reach into new markets on a regular basis. Apple's growth may be slowing from its expected lightning-fast pace, but its forward P/E of nine implies value.
Image source: Gilead Sciences.
2. Gilead Sciences
Gilead Sciences (GILD +1.02%) may not be a household name like Apple, but its dynamic duo of Harvoni and Sovaldi for hepatitis C brought in north of $19 billion in sales during 2015, and helped generate $20.3 billion in FCF. The World Health Organization estimates there are 180 million people infected with HCV worldwide, giving Gilead a sizable and extended market opportunity. It also doesn't hurt that, in terms of convenience and efficacy, Harvoni has been a superstar, and a pan-genotypic HCV therapy is also in development.
On top of hepatitis C, Gilead's HIV franchise with Stribild, and more recently Genvoya, are expected to contribute billions annually. Pharmaceuticals are a smart play in any market because people can't control when they get sick, which tends to lead to strong drug prices. Following the rough start, Gilead is now trading at just seven times forward earnings.
3. IBM
Big Blue may have fallen on hard times of late, but it's still a monster when it comes to legacy enterprise software and an up-and-coming giant in cloud-based software. It's also a company that Warren Buffett has taken a particular liking to. The Oracle of Omaha has scooped up more than 81 million shares of IBM (IBM +1.03%), or nearly 8.5% of outstanding shares. Buffett is arguably the most-followed value investor.
The real story of late has been Big Blue's surging cloud revenue. Cloud revenue grew 57% year over year in 2015 on a constant-currency basis, and totaled $10.2 billion, or close to an eighth of IBM's total revenue. At this pace, around a quarter of IBM's sales could be cloud based by 2018/2019. Following a rough two-year patch, IBM is trading at less than nine times forward profits.
Image source: Teva Pharmaceutical.
4. Teva Pharmaceutical
Back to drugmakers, once again, with Teva Pharmaceutical (TEVA 1.01%). Teva is an interesting case because only half of its business is dependent on innovative brand-name drugs, such as Copaxone XR for relapsing multiple sclerosis. The other half of Teva's revenue generation comes from well over 1,000 unique molecules that it could market generically. Generic medicines may not offer the juiciest margins, but they make up for it in sheer volume. Generics offer endless pipeline potential for Teva.
Like Gilead, Teva benefits from the inelasticity in demand from nearly all of its medicines, brand name or generic. This makes Teva potentially investment-worthy regardless of what the stock market or U.S. economy are doing. Teva is currently trading at a forward P/E that's ever-so-slightly below 10.
5. Qualcomm
Competition might be pressuring Qualcomm (QCOM +0.24%) of late, but the manufacturer of wireless connectivity chips still has a stranglehold command over its rivals. As it pertains to baseband market share, Qualcomm wrangled in 55% share in Q3 2015, and it also gobbled up 16% share in the tablet applications-processor market in Q3. Being such a longtime dominant player in wireless has allowed Qualcomm to establish seemingly unbreakable bonds with its large customers, and it's certainly helped when it comes to predictable cash flow generation.
The real excitement comes when examining Qualcomm's role in the Internet of Things. Imagine medical information being wirelessly sent to your doctor, or your thermostat and refrigerator working together to minimize energy usage. This is the future, and it's a big opportunity for wireless chipmakers like Qualcomm, which is valued at just nine times forward profits.
2016 F-150 Limited. Image source: Ford Motor.
6. Ford Motor
You can still put some pep in your portfolios' step with an automaker like Ford (F 0.71%), which has found a way to take advantage of domestic and foreign growth. Ford's resurgence has come about due to a number of factors. It's focused on improving the feel of its interior cabins by boosting technological amenities and enhancing their spaciousness. It's improved its fuel efficiency in a big way with the implementation of its EcoBoost engine in a broader variety of vehicles. It's even looked to China, the world's largest auto market, to improve sales and profits, and taken care to offer lower price points for first-time buyers in domestic and foreign markets.
Ford also hasn't lost touch with the fact that its trucks and SUVs are its bread and butter. Trucks and SUVs sport better margins than many of Ford's sedans, and in 2015, Ford wound up selling 780,354 F-Series trucks in the U.S., the sixth consecutive year of growth. Ford shares are valued at just five times forward earnings.
7. AbbVie
Last but not least, we again return to the drugmakers, with AbbVie (ABBV +0.06%). AbbVie's Humira, a treatment for a handful of anti-inflammatory diseases, is currently the best-selling drug in the world. AbbVie sales topped the $14 billion mark in 2015, the first time any drug has ever hit that mark.
Image source: AbbVie.
However, AbbVie has more going for it than just Humira. Two drugs in its back pocket, Viekira Pak and Imbruvica, are set to drive growth for years to come. Imbruvica was acquired when AbbVie bought Pharmacyclics for $21 billion, and it looks to completely revolutionize the treatment of certain blood cancers.
AbbVie believes sales of Imbruvica could hit as much as $7 billion at their peak. Likewise, AbbVie should soon have a once-daily HCV version of Viekira Pak on the market, which could bring in billions annually. AbbVie is valued at just nine times forward earnings.
Cash, cash, and more cash!
Aside from all of these companies trading at single-digit P/Es, and having favorable long-term outlooks, they're also FCF giants. Utilizing their 2015 FCF, historical FCF growth, and taking into account various business dynamics, I've estimated total FCF generation between 2016 and 2020 for all seven companies. Keep in mind that this is purely subjective; but here's how much each company could bring to the table in FCF over the next five years:
- Apple: $330 billion
- Gilead Sciences: $85 billion
- IBM: $70 billion
- Teva Pharmaceutical: $25 billion
- Qualcomm: $25 billion
- Ford Motor: $40 billion
- AbbVie: $25 billion
This works out to a cool $600 billion in cumulative FCF by 2020. Imagine how much of that could be used to grow dividends, buy back common stock, or be put to work to boost profitability!
It's probably also worth mentioning that all seven of these FCF giants pay a dividend. If you bought these seven stocks right now, your average yield would be 3.5%! That's more than 50% higher than the broad-based S&P 500.
If you want to put your money to work in a volatile market environment, consider following companies with strong FCF generation that are also attractive values relative to the broader market.
