BT (LSE: BT-A) andSKY (LSE: SKY) are two of the markets most defensive stocks.
The two companies provide multimedia services to customers, which are usually sold on contracts that last for a year, or more. And with the customer paying a regular monthly fee for BT and Skys services, the twomultimedia providers have a regular recurring income.
Moreover, as customers sign contracts for an extended period, BT and Skys revenuesare, to a certain extent, immune from economic trends.
Cash machines
With a recurring income from customers, Skys cash generation is almost unrivalled.
During the past five years, Sky has generated 8.5bn in cash from operations, and the company invest a huge amount to generate such lofty returns. The companys capital spending only amounted to 2.6bn over the same period.
As a result, last year Sky generated 100p per share in free cash flow, whichmeans that currentlySkys shares trade at a free cash flow yield of around 10%.Free cash flow yield offers investors a better measure of a companys fundamental performance than the widely used P/E ratio. A ratio of 10% is highly attractive.
Moreover, Skyhas been able to achieve staggering returns for investors over the past five years. Group return on equity (profit earned in comparison to total shareholder equity) was 64% last year and has averaged around 80% since 2010. Shareholder equity has increased at acompound annual rate of 41% since 2010 while book value per share over the period has risen from 32p to 184p, as reported at the end of last year.
Since 2009, Skys shares have outperformed the FTSE 100 by more than 100%.
These returns should continue for the foreseeablefuture. Sky has recently reported its highest ever level of organic customer growth, and the recent acquisition of European peers should help the enlarged group improve margins thanks to economies of scale.
Skys shares currently support a dividend yield of 3.5%, and earningsare forecast to expand 15% this year.
Working for shareholders
Skys cash generation is almost unrivalled. Indeed, unlike Sky, BT is currently forking out around 2.5bn a year to maintain its fixed telecoms network. As a result, BTs current free cash flow yieldis only 7%.
Still, BTs management has shown over the past five years that it is working to create value for shareholders. Since the end of 2011, BTs earnings per share have almost doubled, while revenue has declined by more than 10%. BT has been cutting costs and moving into more lucrative markets to boost margins, cash flow and grow shareholder equity.
As BTs earnings have expanded, the companys shares have charged higher. Over the past five years, including dividends, BTs shares have returned 29.5% per annum five times more than the FTSE 100 over the same period. As BTs expansion powers ahead, these gains should continue.
BTs shares currently support a dividend yield of 3.3% andtrades at a forward P/E of 14.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended Sky. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.