While the market continues its ascent, investors should consider which stocks offer the most potential going forward. One strategy to pick winners is to look for cash cow stocks. A cash cow is a company that typically has a large share of its market and continuously produces steady cash flow. It is named a cash cow due to the similarity of cows producing milk regularly.

Why might an investor pick a company with a lot of cash over another stock? A company with consistent cash flows typically has excess money to fuel growth by investing in different business segments, or it could reward shareholders through stock buybacks and dividends. Cash cow stock can generate strong returns over the long-term. For instance, the Pacer US Cash Cows Growth ETF (BUL) returned 27.3% last year, compared with only a 16.3% gain for the S&P 500.

The ETF screens the S&P 900 Pure Growth Index for the top 50 companies based on free cash flow yield. Free cash flow is the cash remaining after a company has paid expenses, interest, taxes, and long-term investments. The ability to generate a high free cash flow yield indicates a company produces more cash than it needs to run the business. Some of the top stocks in the ETF are companies I have recommended before, which is why I am highlighting Apple Inc. (AAPL), Dollar General Corporation (DG), and KLA Corporation (KLAC) below.

Apple Inc. (AAPL)

AAPL is one of the largest companies in the world and the biggest name in consumer technology. The company has a healthy balance sheet and a strong business model. It had a whopping $90.9 billion in cash as of the end of the last quarter. It also currently has a free cash flow yield of 3.2%. Like most cash cow stocks, AAPL has a leading market share due to its substantial competitive advantages with the iPhone line, iPads, and now Apple Watches.

In its most recent quarter, the company set records for revenue, earnings, and free cash flow. That performance has continued into the current quarter as its new iPhone with 5G appears to be selling like hotcakes. The phone has been out for a couple of months, and customers are still waiting three weeks for delivery. The phone has also made inroads into China, as the iPhone 12 has sold better than expected in the country, bringing its market share up to 20%.

Its services segment is also performing well. The company reported record gross sales for its App Store for the week between Christmas Eve and New Year’s Eve. Its users spent $1.8 billion in the App Store, up 27% year over year. AAPL also generated $540 million in sales on New Year’s Day. This bodes well for the current quarter as it’s the company’s fastest-growing and highest-margin segment. The company has also waded into the other markets such as Pay with Apple Pay and streaming with Apple TV. It also recently announced that it is working on an Apple Car.

The stock is rated a “Buy” in our POWR Ratings system. It holds a grade of “A” in Trade Grade and a “B” in Buy & Hold Grade and Industry Rank. Those are three out of the four components that make up the POWR Ratings. It is also ranked #21 in the Technology – Hardware industry.

Dollar General Corporation (DG)

DG is the largest discount chain operating almost 17,000 stores. Its stock soared last year as consumers stocked up on products during the lockdown. While many retailers initially struggled during the initial lockdown, DG increased sales with its product staples, low prices, and convenient locations. The company had $2.2 billion in cash as of the last quarter and currently has a free cash flow yield of 5.4%.

Even with the recent stimulus legislation, many Americans are still suffering to make ends meet due to the pandemic’s effect on many households. DG provides people with a selection of name brands at low prices that are competitive with Walmart (WMT) and Target (TGT). Its stores are located in rural and suburban areas close to low-income residents underserved by many big-box retailers.

The company is looking to grow even more by launching new stores and improving its existing stores’ profitability. DG recently announced a new store concept, popshelf, that targets consumers with higher household incomes. These stores will include seasonal and home décor, health and beauty products, home cleaning supplies, party goods, and more, with 95 percent of items priced at $5 or less.

DG announced that it would pay employees to get vaccinated against COVID-19, so it expects strong sales to continue. Its stock is rated a “Strong Buy” in our POWR Ratings system. It holds a grade of “A” for Trade Grade and Buy & Holds Grade and a “B” for Industry Rank. It is also ranked #4 in the Grocery/Big Box Retailers industry.

KLA Corporation (KLAC)

KLAC designs and manufactures yield-management and process-monitoring and control systems. It dominates the process diagnostic and control segment (PDC) of the semiconductor equipment industry. During the fabrication process of semiconductors, wafers must be inspected for defects, and as chips are getting smaller, there is an increased need for PDC tools. KLAC has more than a 50% market share in the PDC market. The company had $2 billion in cash at the end of the last quarter and currently had a 3.6% free cash flow yield.

KLAC should see continued growth due to an industry-wide transition to advanced nodes and EUV lithography insertion. In addition, enhanced wafer cleanliness and geometry specifications in the bare wafer market are increasing demand for KLAC’s wafer products. The company’s new product offerings, including its e-beam platform and expanding addressable market in printed circuit boards, flat panel display, and packaging, bode well for future growth.

KLAC has shown strong sales and earnings growth over the past five years, averaging 15.8% and 19.7%, respectively. I also like its profitability numbers with a return on invested capital of 23.1% and a return on equity of 47.0%. The company has a healthy short-term cash balance, represented by a current ratio of 2.7. It even offers a 1.2% dividend yield.

The stock is rated a “Strong Buy” in our POWR Ratings system. It holds a grade of “A” in Trade Grade, Buy & Hold Grade, and Industry Rank and a “B” in Peer Grade. KLAC is also ranked #14 in the Semiconductor & Wireless Chip industry.

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AAPL shares fell $0.00 (-0.05%) in after-hours trading Wednesday. Year-to-date, AAPL has declined -99.01%, versus a -98.98% rise in the benchmark S&P 500 index during the same period.

About the Author: David Cohne

David Cohne has 20 years of experience as an investment analyst and writer. Prior to StockNews, David spent eleven years as a consultant providing outsourced investment research and content to financial services companies, hedge funds, and online publications. David enjoys researching and writing about stocks and the markets. He takes a fundamental quantitative approach in evaluating stocks for readers. More...

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