For some investors, mid-cap stocks, which can be found in the S&P 400 Mid-Cap Index, are the "Goldilocks" of the stock market. They aren't so big that they can't quickly adjust to changing industry dynamics. And they aren't so small that they suffer the extreme revenue swings from the economy's ebbs and flows.
In recent months, we've been highlighting the virtue of companies that are able to lavishly reward investors with a combination of dividends, share buybacks and debt reductions. Simply put, these companies can only deliver the goods of they have the free cash flow to support it.
High free cash flow is important for another reason: A company's FCF yield can be directly compared to the yield you'll get on other investments, such as CDs, Treasury bills, or annuities. Those products usually offer up small yields, these days, below 3%. In contrast, a few dozen mid-cap stocks offer FCF yields that are twice or three times as high.
Here's a quick snapshot of 15 stocks with FCF yields of 7% or more.
Aecom Technology (NYSE: ACM), which provides civil engineering services, is a great example of why strong FCF sets the stage for great Total Yields. Though Aecom's sales have been stuck around $8 billion in each of the past three years, thanks to the weak environment for infrastructure spending, management has become very adept at squeezing out cash flow. Free cash flow had never exceeded $165 million in any year in its history, but surged above $350 million in each of the past two years.
Why the sudden spike? After years of tuck-in acquisitions, "the company has increasingly shifted its focus to integrating and optimizing these operations, which has improved cash-flow," note analysts at DA Davidson.
Management has been applying the strong FCF to share buybacks: The share count stood at 118 million at the end of fiscal (September) 2011, and now stands at 98 million. There is another $340 million remaining on the current buyback authorization, which could push the share count below 90 million. Aecom is coming off a very strong quarter in terms of new contract wins, and backlog has just moved to a record $18.4 billion. That sets the stage for continued strong free cash flow, and more buybacks to come.
Wisconsin-based Associated Banc Corp. (Nasdaq: ASBC) is another stellar producer of FCF and Total Yield.
Over the past four years, this regional bank has generated a cumulative $1.23 billion in free cash flow. The payoff: The dividend is beginning to grow at a fast pace, though at $0.36 a share (equating to a 2.2% yield), it is still well below the $1 a share dividends that this bank used to deploy. In addition, the share count has fallen roughly 6% in the past six quarters, thanks to ongoing buybacks, during which time the banks has also retired more than $1 billion in debt. You could have anticipated such moves simply by looking at the double-digit free cash flow yield.
Lastly, it's interesting to note a pair of technology firms in the field of electronic design automation (EDA). Back in November, I suggested that EDA firms such as Cadence Design Systems (Nasdaq: CDNS) and Synopsys (Nasdaq: SNPS) might make for tempting acquisition targets for Intel (Nasdaq: INTC), as that tech giant moves deeper into the foundry business.
Frankly, these firms are doing just fine without Intel. Free cash flow hit a record $300 million, and $400 million, respectively, in 2013. Synopsys is applying that to a recently-announced $500 million share buyback program, while Cadence has thus far focused on paying down debt. But with FCF yields now exceeding 7%, both of these firms are likely to step up their Total Yield strategy in coming years.
Risks to Consider: These mid-cap companies are benefiting from a stable economic climate, which is leading to strong free cash flow. But in past economic cycles, their FCF generation has occasionally fallen sharply. Another bout of economic weakness may cause them to pause their Total Yield strategies.
Action to Take --> With the ink now dry on 2013 results for many companies, this is a good time to freshly assess companies' free cash flow characteristics. Those that are now generating robust FCF are the most likely to pursue one or several legs of the Total Yield strategy.