Four Companies With Strong Cash Flow

EVEN HARDENED WALL Street types can remember the story of the three little pigs. The first little pig built his house with straw, only to see the wolf blow it down. The second pig built his house with sticks and suffered the same fate. The third pig took another approach, building his house with bricks. The big bad wolf huffed and puffed, but he couldn't blow it down.

Memo to investors: The lessons of that fairy tale may come in handy in today's brutal market. In corporate finance, cash may well be the equivalent of bricks, and analysts say that companies generating plenty of it are in the best position to withstand the huffing and puffing of a slowing economy. Indeed, the stockpiling of significant heaps of cash is one of the little noted highlights of this market. According to Thomson Reuters, nonfinancial companies have amassed $543 billion, 38 percent more than they had just five years ago. And there's strong evidence that companies that use their cash wisely will see a long-term payoff in the price of their stock. "Cash flow is the lifeblood of a company," says Mark Mowrey, senior analyst at the Al Frank Fund.

A healthy flow of cash, for example, has enabled Johnson & Johnson to boost its dividend 46 years in a row. It has also allowed IBM to buy back billions of dollars' worth of its own shares year after year. But experts say it has also given these blue chips and a select group of other firms the ability to invest in their businesses in both good times and bad. A study of nearly 1,000 firms by consultant McKinsey & Co. found that those using cash in hard times for things like acquisitions and advertising, instead of just cutting costs, emerged much stronger from the 1990-91 recession. Indeed, the market valued these aggressive outfits 25 percent higher than their weaker rivals (based on the ratio of the stock price to book value). Strong cash flow, Mowrey says, allows companies to plow their money into "future talent, future technologies and future growth."

But it's also possible to have too much cash. Investors should be wary of companies that build large war chests but do little with them. Cash can burn a hole in some executives' pockets as well, resulting in ill-conceived acquisitions. That's one reason fund managers stick with companies boasting a track record for handling that cash well. To find the best cash foundations, we searched for companies generating plenty of free cash flow — the money left after reinvesting in their businesses, paying all the bills and giving shareholders a little something — and forecasting earnings growth next year. We threw out companies with shaky balance sheets, then looked for those running their businesses more profitably than they were five years ago. That left us with four picks that even the big bad wolf might find hard to knock down.