Free cash flow (FCF)—or owner earnings, as referred to by the legendary investor Warren Buffett—represents the cash available to shareholders after all other claims have been met. Based on FCF, a good measure of the fundamental strength of a company is its FCF yield, which is calculated by dividing a company’s FCF per share by its current market price per share. A positive FCF yield means the company earns more cash than needed for operations, which then can be used to fund growth, innovate, downsize debt, pay and grow dividends, or fund share buybacks.
While past performance may not necessarily replicate in the future, a few growth stocks with dividend yields exceeding 2.0% currently appear undervalued by their FCF. Here is a closer look at five dividend stocks with FCF yields at or above 6.7% (which is equivalent to a price-to-FCF at or below 15) and past and forward long-term EPS CAGR of at least 5%.
KLA-Tencor Corporation (NASDAQ:KLAC)
KLA-Tencor Corporation (NASDAQ:KLAC), a leader in process control and yield management solutions for the semiconductor industry, has a FCF yield of 7.0%. Last year, the company generated some $650.5 million or $3.86 per share in FCF. Its valuation based on earnings multiples is also attractive, as KLA-Tencor Corporation (NASDAQ:KLAC) trades at 13.6x trailing and 14.3x forward earnings, well below earnings multiples of its peers as a group. The company’s financial performance has been hurt by a slowing PC industry and lackluster economic growth weighing on the semiconductor manufacturing equipment sales, even though robust mobile device sales have supported growth.
KLA-Tencor Corporation (NASDAQ:KLAC) reported first-quarter revenues and EPS above analyst expectations, despite the plunge in both metrics. However, the company missed analysts’ projections for the current-quarter EPS. KLA-Tencor Corporation (NASDAQ:KLAC)’s weaker outlook for the whole year is based on a projected decline in chip companies’ capex of close to 10% compared to the year earlier. Analysts are more upbeat about KLA-Tencor Corporation (NASDAQ:KLAC)’s long-term outlook, forecasting an EPS CAGR of 10%. KLA-Tencor Corporation (NASDAQ:KLAC) has a dividend yield of 2.9%, payout ratio of 42% of last year’s FCF, and five-year annualized dividend growth rate of 22.9%.
Belo Corp (NYSE:BLC)
Belo Corp (NYSE:BLC), an operator of TV stations affiliated with ABC, CBS, NBC, FOX, and CW, has a FCF yield of 9.5%. The company generated nearly $112 million or $1.08 per share in FCF last year, which was more than double the amount in the previous year. The company is one of the largest pure-play television broadcasters, reaching 14.6% of U.S. television households in 15 high-growth markets. The company saw a total revenue growth of close to 3% in the first quarter, and topped analyst estimates of the quarterly EPS.
Its total revenue is projected to be down 1.5% to 2% in this quarter from the prior-year quarter; excluding political revenue it is projected to be up 3% to 3.5%. The company’s catalysts in the future include retransmission, mobile television, multicasting, 2014 political ads and Olympics. In terms of valuation, Belo Corp (NYSE:BLC) is priced at 14.3x and 11.0x its 2013 and 2014 EPS, respectively. However, the stock is trading at a price-to-book of 3.8, which exceeds its five-year historical ratio of 3.4. Belo Corp (NYSE:BLC) pays a dividend yield of 2.9% on a payout ratio of 30% of last year’s FCF.
Marvell Technology Group Ltd. (NASDAQ:MRVL)
Marvell Technology Group Ltd. (NASDAQ:MRVL) is a chipmaker with a FCF yield of 9.1%. The company generated $562 million or $1.00 per share in FCF last fiscal year. Marvell Technology Group Ltd. (NASDAQ:MRVL) is one of the largest holdings in David Einhorn’s Greenlight Capital hedge fund. Due to Marvell Technology Group Ltd. (NASDAQ:MRVL)’s stock buyback activity, Greenlight Capital had to sell 1.7 million Marvell Technology Group Ltd. (NASDAQ:MRVL) shares in early April so as to reduce its beneficial ownership to 9.99%, below the 10% threshold that would make the hedge fund subject to Section 16 of the Securities Exchange Act of 1934. Given that Einhorn also holds a derivative arrangement through total return swaps on Marvell Technology Group Ltd. (NASDAQ:MRVL)shares, his economic interest in the stock equals 12.4%.
Einhorn boosted his Marvell Technology Group Ltd. (NASDAQ:MRVL) stake when the company’s shares plunged after a ruling by a U.S. judge that imposed a $1.1 billion fine on Marvell due to its infringement of two patents held by Carnegie Mellon University. Einhorn believed the fine would be “substantially reduced or eliminated.” Aside from this, Marvell still has a strong growth outlook, as its product pipeline is increasingly focused on the storage and smartphone markets. The company offers a yield of 2.2% on a payout ratio of 24% of last year’s FCF.
Quest Diagnostics Inc (NYSE:DGX)
Quest Diagnostics Inc (NYSE:DGX), a world’s leading provider of diagnostic testing, information and services, has a FCF yield of 9.4%. The company generated $897 million or $5.60 per share in FCF last fiscal year. Quest Diagnostics Inc (NYSE:DGX) has embarked on a robust dividend growth since 2011, increasing its regular dividend cumulatively by 200%. The outlook for continued dividend growth is strong, as the company boasts a low payout ratio of only 21%. Its current yield is 2.0%. The company’s market has been growing and is expected to continue expanding at a 4% rate.
However, Quest Diagnostics Inc (NYSE:DGX) reported first-quarter revenues and EPS well below Wall Street estimates, as its net sales dropped 6.3% and adjusted EPS from continuing operations plunged 15.2%. DGX is focused on restoring growth, targeting a low-single-digit revenue growth through 2015. Still, its revenues will be mainly flat this year, approximating revenue growth in the previous year. The company projects its adjusted EPS between $4.35 and $4.55, compared to $4.36 in 2012. It is committed to achieving a sustainable double-digit EPS growth by 2014, driven by improved operating earnings and stock buybacks. It will also aim to “maintain meaningful dividend which can grow over time with earnings.”
Owens & Minor Inc. (NYSE:OMI)
Owens & Minor Inc. (NYSE:OMI), a provider of healthcare products and third-party logistics and supply-chain management services, has a FCF yield of 7.2%. Its total FCF last year was $153 million or $2.43 per share. Owens & Minor Inc. (NYSE:OMI) has paid dividends since 1926, and has increased them for the past 15 years in a row. Currently, it has a dividend yield of 2.9%, payout ratio of 40% of last year’s FCF, and five-year annualized dividend growth of 13.7%.
The company recently reported a 2.6% increase in first-quarter revenues, driven by the sales contribution from Movianto, a leading European healthcare third-party logistics business which Owens & Minor Inc. (NYSE:OMI) acquired last year. Still, adjusted EPS dropped 4.3% from the prior-year quarter. However, the company expects a turnaround in sales and profitability this year, expecting a 2%-to-4% revenue growth and adjusted EPS in the range of $1.90 to $2.00, up from $1.85 last year. Movianto will lead the company’s near-term sales growth, while innovation and acquisitions will be Owens & Minor Inc. (NYSE:OMI)’s future growth engines.
Final thoughts
Research suggests that stocks boasting high FCF yields have historically outperformed the stocks with low FCF yields, as well as the broader market. Moreover, stocks combining the highest FCF yields and the highest dividend yields have produced the highest total returns when compared to returns based either on dividend yield or FCF yield alone, according to research by asset manager Manning and Napier; learn the secrets of one under-the-radar method investors are using to beat the market.
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