In business, a cash cow is a product or service that generates a steady stream of profits, often with little need for investment. If you're lucky enough to own one, you can relax and watch the money roll in. Because your business has some kind of competitive advantage like a brand or a barrier to entry, competitors will be dissuaded from challenging you.
In investing, it isn't usually this easy as publicly traded companies have to cater to the expectations of investors and the whims of the market, but nonetheless, some companies do have hugely valuable cash cows. Keep reading to see why Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL), McDonald's (NYSE: MCD), and Philip Morris International (NYSE: PM) fit the bill as three top cash cows to own.
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Alphabet's trademark product, Google, is so ubiquitous that it's become a verb in our everyday lexicon. Google is the most visited page on the web and the search engine has dominated the industry since its early days. Search is a natural monopoly, meaning a clear leader will emerge based on the nature of the business. Google's algorithm gets smarter with each search, making it more robust, and allowing it to continue cementing its place as the world's most popular search engine. As such, it has helped its parent company gain a market cap of nearly $800 billion thanks to the advertising business that complements search.
Search has been easy enough to monetize as visitors often go to Google for information on a business, making real estate on Google's web pages valuable. In its most recent quarter, Alphabet recorded $27.2 billion in advertising revenues, which includes businesses like YouTube. Paid clicks on Google properties increased 48% from the year before, which shows that Google is only becoming more vital to digital advertisers. As a result of the strength of that advertising business, the company had an operating margin of 26.1% last year, and $101.9 billion in cash and marketable securities on its balance sheet with less than $4 billion in debt.
With cash quickly accruing, speculation is building that Google will pay a dividend, but management has given no indication that it plans to do so. Given its dominance of search and its growing importance for advertisers, Alphabet's profits should only continue to grow.
McDonald's founder Ray Kroc famously said he wasn't in the burger business, but the real estate business. While McDonald's is best known as a purveyor of burgers, fries, and other fast-food staples, the company's business model is as a franchisor. With the exception of a small percentage of company-owned stores, it owns real estate and franchises the stores that sit on that land to partner operators. That model has been undeniably successful. Not only has McDonald's become the world's most valuable restaurant chain, but the franchise business is a definitive cash cow as there is no shortage of willing McDonald's operators.
While most restaurant businesses operate with single-digit or low double-digit profit margins, the success of McDonald's franchise model, after a slew of refranchising last year, gave it an operating margin of 41.9% last year. The company has also delivered strong comparable sales growth recently thanks to the addition of all-day breakfast and a revamped dollar menu.
With more than $8 billion in before-tax income, the company is clearly sitting on a cash cow. Unlike Alphabet, McDonald's returns most of its cash to shareholders through share buybacks and dividends, so it only has $2.7 billion in cash on its balance sheet. Through the first three quarters of the 2017, McDonald's made $2.8 billion in free cash flow, but spent $6.2 billion on dividends and share buybacks, funding the difference with debt.
McDonald's is a Dividend Aristocrat and pays a yield of 2.6%. With the success of its franchise model, investors can expect its 42-year streak of dividend hikes to continue for years to come.
3. Philip Morris International
Tobacco stocks may seem like questionable investments these days as smoking rates are falling, but declining industries don't attract new competitors and therefore can be home to some of the biggest cash cows. Philip Morris, which controls the Marlboro brand internationally, offers one such example.
Altria, its former parent, which sells the same brands as Philip Morris domestically, was the best-performing stock on the market from 1965 to 2015 with dividends included, according to Wharton professor and stock market expert Jeremy Siegel. Altria's and Philip Morris's success, along with that of other tobacco companies, is due in large part to the nature of the product. Cigarettes are cheap to make but due to their addictive nature and the help of a brand name like Marlboro, which is the world's top-selling brand, they can be sold at a considerable profit.
In 2017, Philip Morris reported an operating margin of 15.3%, but that figure was skewed by excise taxes it must collect around the world. Without those, the company would have an operating margin of 40%, showing that cigarettes remain a profitable business even with steep excise taxes and heavy regulation.
Though growth in cigarettes is challenged, Philip Morris is investing in heated tobacco products like vaporizers, which are growing in popularity in Asia.
Including its history as part of Altria, Philip Morris is also a Dividend Aristocrat and today offers a yield of 4.2%. While cigarette consumption may continue to decline, the ability to raise prices and tap into growth with new vape products should help the company deliver growth and remain a Dividend Aristocrat.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A and C shares). The Motley Fool has a disclosure policy.