With the markets trading near all-time highs, its important to diversify the portfolio in anticipation of potential profit booking.
A good way for diversification is to hold some cash-rich stocks in the portfolio. In general, these companies have a relatively stable business and healthy free cash flows. Value creation is therefore through stock upside, share repurchase, and dividends.
In addition, I am focusing on companies that are innovation driven. These cash-rich companies have been scouting for acquisition of innovation-driven start-ups. This provides trigger for long-term earnings growth.
Let’s look at four cash-rich stocks that are worth holding in the core portfolio.
- Apple (NASDAQ:AAPL)
- Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL)
- Alibaba Group (NYSE:BABA)
- Microsoft Corporation (NASDAQ:MSFT)
When it comes to talking about cash-rich stocks, Apple stock deserves the first mention. For the third quarter of 2020, the company reported $93 billion in short-term cash and marketable securities. In addition, the company has invested another $100 billion in long-term marketable securities.
Its also worth mentioning that for the first nine months of the current fiscal year, the company has delivered $60 billion in operating cash flows (OCF). With strong OCF, there is a clear visibility for further increase in cash.
The first major advantage is that Apple has ample financial headroom for organic and inorganic growth. The company has been pursuing acquisition of innovation driven start-ups. Over the long-term, this will trigger top-line and earnings growth.
Furthermore, shareholders stand to gain on a sustained basis from dividends and share repurchase. The company already has an annual dividend of $3.28 per share and I expect dividends to continue increasing.
I also see Apple as a diversified company in the coming years with the services and wearable segment showing healthy growth. Even in terms of regional diversification, the company has scope for top-line expansion from Asia-Pacific (excluding China).
Overall, AAPL stock is a core portfolio stock that is likely to reward investors with stock upside and dividends. The cash glut can potentially accelerate growth through attractive acquisitions and investment in innovation.
Alphabet (GOOG, GOOGL)
I believe that Google stock is another core portfolio stock with the business being a cash machine. In addition, GOOG stock has a low beta of 1.04. This makes the stock suitable for defensive portfolio.
As of June 2020, Alphabet reported $121 billion in cash and equivalents. In addition, the company has an annualized operating cash flow potential of approximately $50 billion. For the first half of 2020, the company delivered free cash flow of $14 billion.
Clearly, there is ample scope for shareholder value creation through the cash glut, which is bound to increase. In terms of specific segments that can drive growth, I am bullish on Google Cloud business. For Q2 2020, the company’s cloud revenue increased by a robust 43% on a year-on-year basis. Amazon (NASDAQ:AMZN) and Microsoft remain leaders in the cloud business, but there is ample scope for multiple players to grow.
I am also bullish on growth from Alphabet’s self-driving technology development company, Waymo. In the last quarter, the self-driving company received total funding of $3.2 billion. This includes funding from external investors and Alphabet. This is a long-term project, but has a promising outlook.
Overall, GOOG stock has delivered 37% returns in the last year. I see more juice in the rally with positive business developments and cash flow growth.
Alibaba Group (BABA)
Alibaba Group is another one of the cash-rich stocks that I would include in the core portfolio. BABA stock has been trending higher with an upside of 66% in the last year. I see more upside for the stock as strong earnings growth sustains along with cash flow growth.
From a cash perspective, Alibaba reported cash and short-term investments of $54 billion as of June 2020. Importantly, for the most recent quarter, the company delivered free cash flow of $5.2 billion. This implies an annualized cash addition of $20 billion.
I expect FCF to accelerate in the coming years. First, the company’s core commerce business is likely to grow at a strong pace in China and Southeast Asia. Further, I expect cash flows relatively soon from the company’s cloud segment. Alibaba happens to be the largest cloud service provider in Asia Pacific.
With the cash glut, Alibaba is also well positioned for inorganic growth. The company has pursued acquisitions in the past. Given the cash buffer, I see more acquisitions coming.
For long-term investors, Alibaba also gives quality regional diversification.
Microsoft Corporation (MSFT)
With a beta of 0.9, MSFT stock is a quality defensive stock with steady dividend growth visibility. The stock has also trended higher by 59% in the last one year.
In terms of cash, Microsoft reported a buffer of $136 billion as of June 2020. Further, with an annual operating cash flow of $60 billion, the company’s business is a cash flow machine.
I mentioned earlier that Microsoft is among the top two players in the cloud business. For FY2020, the company reported 24% year-on-year growth in the intelligent cloud business to $48.3 billion. This segment is likely to remain the key growth driver.
I want to add here that Microsoft acquired a UK-based firm Metaswitch Networks in May 2020. Metaswitch “specializes in virtualised, cloud-based communications software.” With this acquisition, the company has also made inroads in the 5G market. In FY2020, the company also acquired Affirmed Networks, which is another 5G focused company. Therefore, this can be another potential area of big growth for Microsoft.
For Microsoft, analyst estimates point to annual earnings growth of 13.7% over the next five years. If this holds true, I expect healthy cash flow upside along with sustained dividend growth. Microsoft stock is therefore attractive even after a strong rally in the last few months.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.