3 Stocks With Heaps of Free Cash Flow

In the U.S., interest-bearing checking accounts pay an average of 0.6%, according to Bankrate.com. One-year certificates of deposit pay just 1.8%. The companies listed below don’t offer the same principal guarantee as banks do on deposits, of course. But they pay much more. Each has a dividend yield that tops 3%. And each generates yearly free cash equal to more than 10% of its stock market value—a sign that those dividends are affordable.

Free cash flow is generally a sign of financial strength. A company that produces it consistently shows it’s not just tending to the paper earnings that Wall Street fixates on, but it's producing real cash that can fund dividends, share repurchases and expansion. Compare free cash flow with a company’s stock price by looking for high free cash flow yields, and you can use the measure to help identify potential stock bargains while favoring companies that are prosperous and strong, like the following three.

Lockheed Martin

Free Cash Flow Yield: 12%
Dividend Yield: 3%

Shares of the Bethesda, Md.-based defense contractor have fallen about 10% this year, while the broad market has rallied. The stock now sells for 10 times forecast 2009 earnings, a discount of about 40% to the market. Fears of cuts to America’s weapons spending are weighing on the stock; the U.S. Senate recently voted to remove funding for Lockheed’s F-22 fighter jets from the 2010 defense budget. Also, a confluence of small events, like a contract dispute with New York City over work on subway cameras, hurt the company's second-quarter earnings. Regardless, these shares seem to be a good deal. Industry watchers say government money not spent on F-22s might go toward buying more next-generation F-35s, which are already well-funded by Congress and carry fatter profit margins for Lockheed (LMT: 74.56, -1.04, -1.37%). And recent stumbles show little sign of doing lasting damage. The company’s sales are expected to increase 6% both this year and next.

Eaton

Free Cash Flow Yield: 14%
Dividend Yield: 3.6%

Cleveland-based Eaton (ETN: 52.79, -0.31, -0.58%) makes electrical systems, hydraulics, car and aircraft components and other goods that are sensitive to the business cycle. Demand for its wares has been shattered by the present recession with companywide sales expected to drop 23% this year. Shares are barely half their price of two years ago. But Eaton has a strong balance sheet and still generates plenty of free cash. Shares are 26 times this year’s depressed earnings forecast, but are less than 10 times what the company earned in each of the past three years. Patient investors can collect dividends on the shares now while awaiting an economic recovery that should drive company profits and the stock price higher.

Pfizer

Free Cash Flow Yield: 15%
Dividend Yield: 3.8%

Pfizer (PFE: 16.28, -0.10, -0.61%) chose poorly, in my opinion, when it halved its dividend at the end of January to afford a purchase of rival drug maker Wyeth. Investors seem quick to forgive, however. They dragged the stock down 40% during the month following the news, but have since bid it back up -- and then some. Analysts say the two companies are a good fit, since Pfizer has tired products but plenty of marketing savvy, while Wyeth has fresher drugs but could use some help pushing them. So large was Pfizer’s yield before that half of it is still sizable: 3.8%. And despite the recent run-up, shares still seem cheap at eight times forecast 2009 earnings.