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Is Silver Wheaton a Cash King?

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As an investor, you know that it pays to follow the cash. If you figure out how a company moves its money, you might eventually find some of that cash flowing into your pockets.

In this series, we'll highlight four companies in an industry, and compare their "cash king margins" over time, trying to determine which has the greatest likelihood of putting cash back in your pocket. After all, a company can pay dividends and buy back stock only after it's actually received cash -- not just when it books those accounting figments known as "profits."

Today, let's look at Silver Wheaton (NYSE: SLW  ) and three of its peers.

The cash king margin
Looking at a company's cash flow statement can help you determine whether its free cash flow backs up its reported profit. Companies that can create 10% or more free cash flow from their revenue can be powerful compounding machines for your portfolio. A sustained high cash king margin can be a good predictor of long-term stock returns.

To find the cash king margin, divide the free cash flow from the cash flow statement by sales:

Cash king margin = Free cash flow / sales

Let's take McDonald's as an example. In the four quarters ending last June, the restaurateur generated $6.87 billion in operating cash flow. It invested about $2.44 billion in property, plant, and equipment. To calculate free cash flow, subtract McDonald's investment ($2.44 billion) from its operating cash flow ($6.87 billion). That leaves us with $4.43 billion in free cash flow, which the company can save for future expenditures or distribute to shareholders.

Taking McDonald's sales of $25.5 billion over the same period, we can figure that the company has a cash king margin of about 17% -- a nice high number. In other words, for every dollar of sales, McDonald's produces $0.17 in free cash.

Ideally, we'd like to see the cash king margin top 10%. The best blue chips can notch numbers greater than 20%, making them true cash dynamos. But some businesses, including many types of retailing, just can't sustain such margins.

We're also looking for companies that can consistently increase their margins over time, which indicates that their competitive position is improving. Erratic swings in margins could signal a deteriorating business, or perhaps some financial skullduggery; you'll have to dig deeper to discover the reason.

Four companies
Here are the cash king margins for Silver Wheaton and three industry peers over a few periods.

Company Cash King Margin (TTM) 1 Year Ago 3 Years Ago 5 Years Ago
Silver Wheaton 62.8% 29% (21.6%) (153.3%)
Yamana Gold (NYSE: AUY  ) 16.8% 12.7% (11.4%) (185.4%)
Agnico-Eagle Mines (NYSE: AEM  ) 7.7% (10.8%) (164.6%) 11.3%
Goldcorp (NYSE: GG  ) 12.5% 10% (13.5%) 20.5%

Source: S&P Capital IQ.

Silver Wheaton, Yamana, and Goldcorp all exceed our 10% threshold for attractiveness. Silver Wheaton looks especially impressive, with current cash king margins at 62.8% and steady and dramatic increases in its margins over the past five years. Yamana has also offered the kind of steady growth we like to see, while Goldcorp's margins have declined by 8 percentage points from five years ago. Agnico-Eagle has current margins below 8%, and they are down by more than 3.5 percentage points from five years ago.

Silver Wheaton has a different business model from most other mining stocks. Instead of mining its own resources, it pays cash upfront to other mining companies for the right to buy their silver at low fixed costs. This provides needed financing to miners like Goldcorp but allows Silver Wheaton to gain a greater benefit from rising silver prices. However, this can also make Silver Wheaton a more volatile stock.

Silver Wheaton started offering a modest dividend last year, which it has already tripled, and offers a current yield of 1.2%. This makes the company a more tolerable income play if you can weather the volatility. However, Goldcorp matches Silver Wheaton's dividend yield, and some of its competitors offer better yields, with Yamana providing a 1.3% yield and Agnico-Eagle Mines a 1.6% yield.

The cash king margin can help you find highly profitable businesses, but it should only be the start of your search. The ratio does have its limits, especially for fast-growing small businesses. Many such companies reinvest all of their cash flow into growing the business, leaving them little or no free cash -- but that doesn't necessarily make them poor investments. Conversely, the formula works better for slower-growing blue chips. You'll need to look closer to determine exactly how a company is using its cash.

Still, if you can cut through the earnings headlines to follow the cash instead, you might be on the path toward seriously great investments.

Want to read more about Silver Wheaton? Add it to My Watchlist, which will find all of our Foolish analysis on this stock.

Jim Royal owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (1) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 08, 2012, at 6:20 PM, mhonarvar wrote:

    If you like SLW- check out Sandstorm Gold (TSX:SSL) and Sandstorm Metal & Energy

    (TSX:SND). These were both set up by Nolan -former CFO of SLW. They are fairly new ventures that

    aim to stream gold (for SSL) and metal, coal and oil (for SND). They both have streams producing revenues already and have the potential to replicate

    SLW's success.

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Related Tickers

10/25/2016 3:31 PM
SLW $24.37 Up +0.52 +2.18%
Silver Wheaton CAPS Rating: ****
AEM $49.72 Up +1.43 +2.96%
Agnico-Eagle Mines CAPS Rating: **
AUY $3.88 Up +0.15 +4.02%
Yamana Gold CAPS Rating: ***
GG $15.67 Up +0.38 +2.49%
Goldcorp CAPS Rating: ***