Three cash-laden US stocks to buy now
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David Stevenson Feb 15, 2010
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US companies are laden with cash
We're in the aftermath of a severe credit crunch. So you may be surprised to learn that American companies are currently flush with cash.
A total of $1.18 trillion is sitting around on the balance sheets of the companies that make up the US S&P 500 index, says Bloomberg. Widespread cost cutting has worked a treat. More than half of these firms have increased their cash balances compared with last year.
Even so, the dividend yields on many US stocks are rubbish at the moment. The yield on the S&P is only just above 2%.
But that could now change. Some US company bosses will be looking to hand part of their money mountains back to their shareholders in the form of dividends. Here's how you can cash in on this...
US business is all cashed up with nowhere to go
How does a firm make more money when it can't ring up the sales increases that it used to?
Answer: by cutting costs. Over the last two years in the States, capital investment (capex) has been chopped, factories have been shut, stocks reduced and lots of workers have been sacked.
It's worked out very well so far. Productivity - that's the amount produced per employee - has jumped as jobs have been eliminated. So US firms have managed to rebuild their profits from the big earnings slump at the end of 2008.
Corporate cash flow, after allowing for capital expenditure and dividend payments, is nearly back to the peak levels of early 2008. What's more, according to analysts' forecasts, profit margins will have recovered to near-peak levels by the end of 2010.
On the surface, that sounds very healthy for American businesses. And it hasn't escaped the stock market's notice. The S&P 500 index is up by 58% from its lows of early March last year.
The trouble is, simple cost-cutting isn't a recipe for long-term growth. That needs rising sales and more capex. On both scores, the outlook is very iffy.
As David Rosenberg of Gluskin Sheff points out, the US housing market still has loads of problems. And bank lending "continues to implode – it's down by $100bn in just the last month, in excess of a 12% annualised decline". Meanwhile, those job losses mean fewer people around with spare money in their pockets.
These factors will keep consumer spending right under the cosh. The latest University of Michigan consumer confidence gauge - one of the most widely-watched barometers of the US retail scene - fell in February. And the 'expectations' index, which matters most for future spending, hit its lowest point since November. "US consumers remain remarkably depressed", says Paul Dale at Capital Economics. "It won't be long before the overall economic recovery fades".
In other words, US business is all cashed up with nowhere to go. Firms are going to be very wary about big capex plans, or re-employing staff, while demand is deteriorating again. Many management teams who've been steadily hoarding ever-more money will want to sit on their hands and do nothing with it.
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Three stocks with money to hand back to investors
So all that corporate cash won't suddenly become a launch pad from which the overall stock market can take off again. But for some individual stocks, it will be a different story. Some of that money mountain will be handed back to shareholders.
And those shares will be worth buying. But which are they likely to be?
I've been looking for stocks that meet five criteria. First, world leaders in their fields. Second, net cash, i.e. after deducting borrowings, on the balance sheet. Third, a p/e ratio at least 15% cheaper than the overall market. Fourth, a yield at least 50% more than the 2% yield on the S&P 500 index. And fifth, forecast dividend growth of at least 8% over the next three years, according to Bloomberg data.
The world's biggest drug maker...
Top of my list is the world's biggest drug maker: Pfizer (NYSE: PFE). It's perhaps not an obvious first choice, because the company blotted its copybook in many income investors' eyes last year when it cut its dividend to help pay for the acquisition of vaccine specialist Wyeth. And then there are concerns over patent expiries. This is when rivals are allowed to produce cheap copies of a pharma group's blockbuster drugs, hammering sales.
But this has left Pfizer cheap. At $17.73 it's on a current year p/e of 8.2, which is forecast to drop to 7.7 next year. Also, the prospective yield is 4.4%, which is expected to increase to 4.7% in 2010. "Not only do we expect Pfizer's dividend to grow meaningfully over the next four to five years", says Chris Schott at JP Morgan, "we expect the company to pay down the majority of its debt and still generate ample excess cash flow to build out its product portfolio".
...and its largest chip maker
Next, the world's largest chip maker: Intel (Nasdaq: INTC). It has cut its workforce by 15% since 2006. Capex as a percentage of revenue has shrunk by 60% since 2001. Last year's fourth-quarter figures were much better than expected, leaving the shares at $20.43 on a forecast current year p/e of 12.3, well below the industry-wide average of 15.
On top of that, the valuation multiple is expected to fall to just 11.1 in 2011. For a stock that once traded on a 2011 p/e of 67, that's some climb down. It all makes Intel very much an "under-loved value stock that could offer upside of 25% or more over the next few years", says Jacqueline Doherty in Barron's. Following last month's 12.5% quarterly dividend increase, the prospective yield is 3%.
A company that's held its own in the recession
Finally, outsourcer Automatic Data Processing (Nasdaq: ADP), the world's largest payroll processing company. It has held its own in the recession, and now demand for the firm's services is picking up again – ADP has just announced better-than-forecast quarterly profits. At $40.59, it's a bit pricier than the others on a forward p/e of 16, but the prospective yield is 3.3%.
As other companies' cashback plans are revealed in the future, we'll write about them, too. But for now, these three look a good start to us.
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