Four high-quality stocks for the long run

High-quality stocks with good cash flow, high returns on capital and low debt levels are cheaper than at any point in the last decade, says professional investor Hugh Yarrow. Here he picks four stocks capable of generating long-term shareholder value.

By Hugh Yarrow

published 6 November 2009

in Features

Each week, a professional investor tells MoneyWeek where he'd put his money now. This week:Hugh Yarrow, manager of the Evenlode Income Fund.

Riskier equities have outperformed strongly since the market bottomed in March, helped by huge monetary stimulus and a general sense that the economy has stabilised. Many highly indebted, cyclical stocks are pricing in a strong, sustained recovery that may or may not happen. However, plenty of defensive firms look good value, having lagged the market recovery. High-quality stocks with reliable cash flow, high returns on capital and low debt levels are at their cheapest, relative to low-quality stocks, than at any point in the last decade. Here are four capable of generating long-term shareholder value and trading on attractive cash flow and dividend yields.

First off is Unilever (LSE: ULVR), which sells 160 million products, ranging from Marmite to Lipton Ice Tea. Half of the firm's sales are made to developing countries, where the consumption of packaged food and household goods will grow rapidly over the next 10 to 20 years as consumers spend their new disposable incomes. We like the firm's ability to combine stable, steady cash generation from developed markets with fast growth from markets such as Asia, Africa, Latin America and Russia. The stock offers a 4% dividend yield, backed by strong cash flow.

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Next is Domino Printing (LSE: DNO), which manufactures the printers that put best before dates and bar codes on packaged goods, mainly for the consumer staples and pharmaceutical industries. Much of its cash flow comes from maintenance contracts, spare parts and replacement ink. This has grown steadily and is relatively unaffected by economic contraction as long as firms are producing goods, they need their printers and replacement ink. Longer term, Domino will benefit from the production of packaged goods in developing nations. Of new printer sales, 30% originate in India and China, where Domino has direct distribution networks. The dividend yield is 4.5% and cash exceeds debt on the balance sheet.

United Business Media (LSE: UBM) has undergone a huge change over the last five years. It used to be a predominately UK-based publisher of business magazines. Now it owns a portfolio of global media brands, with only 6% of profits coming from the UK. Its largest business is now global trade shows it puts on Hong Kong's largest jewellery fair, for instance. Trade shows are one of the few media areas that has proved resilient in the face of the internet revolution. It seems people still value the opportunity for face-to-face interaction. Once a trade show becomes established, repeat bookings rise reliably and profit margins become attractive. Although revenues are under some pressure, the business is cash generative with low debt. The stock currently yields 5.2% and looks very cheap on a cash-flow basis.

My last tip, De La Rue (LSE: DLAR), is the largest private printer of banknotes in the world and produces more than 150 currencies. Big economies, such as the US, China and Russia, print their own money. But smaller ones may lack the required expertise or capital, which is where De La Rue comes in. This is a business with high barriers to entry that generates plenty of surplus cash. However, the stock has underperformed by more than 50% in the last seven months as investors have focused on more exciting' areas of the market. De La Rue's dividend yield is 5%.

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