Although it has been more than a year since the United States lost its top-tier "AAA" credit rating from Standard & Poor's, the significance of the event is still a bit hard to fathom.
Think about it -- for so many decades, the United States had the perfect credit rating, with essentially no chance of default. Now, with its rating cut to "AA+," there is a chance the country could default on its loans. To make things worse, it has been reported that the other major ratings agency, Moody's, could kick the United States down a notch, if Congress doesn't reach an acceptable budget agreement by year-end.
If Moody's ends up lowering the U.S. credit rating from the current "Aaa" to "Aa1," then a handful of individual stocks would actually have better credit ratings than the U.S. government in the eyes of Standard & Poor's and Moody's. Mind you, only four stocks enjoy a flawless credit-rating distinction today, compared with about 60 during 1980s.
And these four stocks are at the top of the ratings heap for a good reason.
1. Exxon Mobil Corp. (NYSE: XOM)
The venerable oil and gas giant typically generates gargantuan amounts of cash that are usually far more than necessary to cover its debt. Right now, for example, free cash flow is $22.8 billion a year and analysts project it will grow 9% annually to reach about $35.1 billion in 2017. By comparison, the company has debt of $10.7 billion coming due during that same period, so the available cash will be enough to cover interest payments 25 times over.
Besides easily meeting all debt obligations, look for Exxon Mobil to keep making acquisitions, raising its dividend -- like it has every year for the past 30 years -- and buying back stock. With production at the equivalent of nearly 18 billion barrels of oil annually and proven reserves of 25 billion barrels, the company should have enough production and reserves to keep churning ahead for at least another half century, analysts estimate, making this a true "Forever Stock."
2. Microsoft Corp. (Nasdaq: MSFT)
The world's largest software maker has even more free cash flow than Exxon Mobil -- $29.3 billion -- and less debt, about $6.8 billion, coming due during the next five years. Total equity is more than twice total liabilities ($121.3 billion vs. $54.9 billion). Plus, with total cash reserves of about $63 billion and with analysts projecting an 11-12% growth rate in free cash flow to about $50 billion in five years, Microsoft should be able to service debt comfortably, while continuing to expand.
Revenue growth initiatives in the near future include the Oct. 25 release of the Windows 8 operating system for a broad range of devices, which includes PCs, tablets and smartphones. Also, the next generation of Microsoft Office is nearly complete and could be ready for release before the end of the year. Analysts project 2013 revenue of $80.5 billion, 9% more than the $73.7 billion the company is on track to generate in 2012.
3. Johnson & Johnson (NYSE: JNJ)
Despite paying $19.7 billion for the Swiss medical device firm Synthes Inc. in a deal that closed on June 14, the world's largest and most diverse health care company is in no danger of losing its "AAA" rating. This will be true even with other possible acquisitions in the near future like Boston Scientific Inc. (NYSE: BSX), an $8 billion-dollar medical device company Johnson & Johnson is rumored to be eyeing.
At this point, Johnson & Johnson still has about $32.3 billion of cash and cash equivalents. And the company's diverse lines of business should keep generating plenty of free cash flow, which has averaged nearly $13 billion a year for the past five years. Besides permitting ongoing acquisitions, strong cash flow should continue to allow Johnson & Johnson to raise its dividend -- as it has done every year for the past 45 years. The current per-share payout of $2.44 is good for an attractive yield of roughly 3.5%.
4. Automatic Data Processing (Nasdaq: ADP)
With a market capitalization of $28.6 billion, ADP is by far the smallest of the four companies with a "AAA" credit rating (Exxon Mobil, for instance, has a $425 billion market cap). Yet the nation's largest provider of payroll, human resources and other business outsourcing services deserves its place in this elite group. Total debt of $17.3 million is just a tenth of annual free cash flow, which is currently about $1.7 billion and projected to grow 8.5% annually to $2.6 billion in five years, according to analysts. Total debt is also just 3% of shareholders' equity ($6.1 billion).
Prospects for the future are bright because ADP typically retains clients for more than 10 years. Such a high degree of loyalty has enabled the company to raise prices without much resistance. Yet, with a 560,000-member client base, the company can also compete on price without pressuring margins. The net margin, for instance, has averaged 13% a year during the past three years, compared with just 4% for the overall industry.
Risks to Consider: As the United States has demonstrated, even a seemingly invincible "AAA" rating isn't necessarily set in stone. Some bad acquisitions, overuse of debt or poor management could quickly jeopardize the pristine status of any of the companies described here.
Action to Take --> Each stock described in this article has a long history of profit and growth, smart use of debt and strong dividends. They're also some of the world's greatest businesses. In fact, they're just the sort of stocks StreetAuthority co-founder Paul Tracy talks about in his Top 10 Stocks newsletter. Any one of these stocks is worth considering in your own portfolio.