We've all heard the mantra "cash is king." But a fistful of dollars today deserves the royal treatment more than a wad of cash down the road. We want our companies turning their products into cash -- fast!
The cash conversion cycle
Enter the cash conversion cycle. It tells us how quickly a company turns cash invested in inventory into cash in the bank after collecting credit sales from customers and paying off its suppliers. The faster a company can turn over its inventory, the more efficiently it's managing its assets. There are three components of the cycle, and here's how they operate:
-
Days Inventory Outstanding (DIO)
Inventory sitting on store shelves or in stockrooms is not doing the company, or the investor, any good. The number of days the inventory sits there measures how quickly management can get those Speedos off the racks and onto the beaches of Oahu. Obviously, lower numbers are better.
DIO = (average inventory/annual cost of goods sold) * 365 days
-
Days Sales Outstanding (DSO)
Outstanding sales are those the company hasn't yet been paid for; they're languishing in accounts receivable. We want our companies to not only make quick sales, but also get paid for them right away. The faster, the better.
DSO = (average accounts receivable/annual sales) * 365 days
-
Days Payable Outstanding (DPO)
While we want customers to pay us quickly, we want to take our sweet time paying our bills. By paying suppliers slowly, cash is available to spend on things the company needs, like inventory, so we want this number to be higher.
DPO = (average accounts payable/annual cost of goods sold) * 365 days
Putting it all together
With the three pieces of the puzzle calculated, we can figure out how long a company is taking to get paid for the products its customers are buying from inventory, minus the number of days it takes it to pay its suppliers. The cash conversion cycle, or CCC, equals DIO + DSO - DPO.
Not only are these aluminum producers popular within the industry, considering the wave of consolidation taking place, they are also popular among Motley Fool CAPS investors. All of them get top ratings of four or five stars.
|
Company
|
DIO
|
+
|
DSO
|
-
|
DPO
|
=
|
CCC
|
CAPS Rating (out of 5)
|
|
Alcoa (:AA)
|
55.5
|
+
|
38.0
|
-
|
41.5
|
=
|
52.0
|
****
|
|
Aluminum Corp. of China (NYSE:ACH)
|
66.9
|
+
|
11.1
|
-
|
17.1
|
=
|
60.9
|
****
|
|
Alcan (NYSE:AL)
|
59.6
|
+
|
46.5
|
-
|
39.2
|
=
|
66.9
|
****
|
|
BHP Billiton (NYSE:BHP)
|
82.2
|
+
|
28.2
|
-
|
75.1
|
=
|
35.3
|
*****
|
|
Rio
Tinto (NYSE:RTP)
|
59.4
|
+
|
42.5
|
-
|
55.2
|
=
|
46.7
|
****
|
|
Norsk Hydro (NYSE:NHY)
|
58.3
|
+
|
68.2
|
-
|
53.9*
|
=
|
72.6
|
*****
|
Source: Capital IQ, a division of Standard & Poor's. *As of Dec. 31, 2006.
Each week, we look for the top companies in different industries that make fast cash, and while not every company that makes fast cash will excel, we generally only want those firms that the CAPS community considers the best. Four- and five-star stocks are the ones CAPS investors deem most likely to outperform the S&P 500, but since they're all top-ranked stocks, we'll take a closer look at BHP Billiton, which is able to turn raw ore into cash faster than any of the others.
Of course this isn't a list of stocks to buy or sell -- just a jumping-off point for further research.
The not-so-lonely star
Although BHP is something of a laggard when it comes to moving its inventory of metals out, it makes up for it by getting paid quickly by its customers and dragging its feet when paying its suppliers. It's that market power that sets it ahead of its rivals.
More than 1,300 CAPS investors cast their votes for BHP Billiton, and 98% believe it will outperform the market. All-Stars -- CAPS investors who consistently outperform their peers over time -- are nearly unanimous in their belief that it will beat the market.
Top-rated All-Star EBNuc, with a 93.90 player rating, points out that BHP's exposure to an array of commodities beyond aluminum positions it for outperformance.
Commodities are the place to be ... plus China Uranium connection, plus the solidifying Australian economy is a great backdrop, plus diamonds. This has short-term pop potential, long-term growth potential, and serious diversification all in one ...
Don't be foiled again
So which company will continue to mine for the cash? Tell us your picks at Motley Fool CAPS as you work with more than 70,000 of your fellow Foolish investors to uncover the best stocks and convert your money into cash profits. It's free!
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