How Does Silver Wheaton Boost Its Returns?

As investors, we need to understand how our companies truly make their money. A neat trick developed for just that purpose -- the DuPont Formula -- can help us do so.

So in this series we let the DuPont do the work. Let's see what the formula can tell us about Silver Wheaton (NYSE: SLW  ) and a few of its peers.

The DuPont Formula can give you a better grasp on exactly where your company is producing its profit, and where it might have a competitive advantage. Named after the company where it was pioneered, the formula breaks down return on equity into three components:

Return on equity = net margin x asset turnover x leverage ratio

What makes each of these components important?

  • High net margins show that a company can get customers to pay more for its products. Luxury-goods companies provide a great example here.
  • High asset turnover indicates that a company needs to invest less of its capital, since it uses its assets more efficiently to generate sales. Service industries, for instance, often lack big capital investments.
  • Finally, the leverage ratio shows how much the company is relying on liabilities to create its profits.

Generally, the higher these numbers, the better. That said, too much debt can sink a company, so beware of companies with very high leverage ratios.

So what does DuPont say about these four companies?

Company

Return on Equity

Net Margin

Asset Turnover

Leverage Ratio

Silver Wheaton 26.9% 88.1% 0.27 1.14
Yamana Gold (NYSE: AUY  ) 7.9% 26.6% 0.21 1.42
Agnico-Eagle Mines (NYSE: AEM  ) 3.3% 6.7% 0.33 1.51
Goldcorp (NYSE: GG  ) 9.4% 29.8% 0.20 1.38

Source: S&P Capital IQ.

Silver Wheaton's return on equity is head and shoulders above its industry peers. It manages to do so largely because of its high net margins, which are nearly 3 times as high as the next highest in that category. Its asset turnover, on the other hand, is comparable with its industry peers, and it has the lowest leverage ratio of the listed companies.

Silver Wheaton has a different business model from most other mining stocks in that it offers upfront cash payments to other mining companies for the right to buy their silver at low fixed costs in the future. This approach is appealing to Goldcorp, for example, because it got needed financing upfront, and it allows Silver Wheaton to gain more benefit from rising silver prices. Silver Wheaton started offering a modest dividend last year, which it has already tripled. It currently offers a yield of 1.2%. The payout makes the company a more tolerable income play if you can weather the volatility.

Goldcorp's pattern of aggressive acquisition of new mining resources has allowed it to take strong advantage of the bull market in gold. In 2010, the company acquired Andean Resources (along with its Cerro Negro property), the Camino Rojo property, and a 70% interest in the El Morro project in Chile. The acquisition of the Cerro Negro property was particularly significant, as it will help Goldcorp grow its gold production at a low cost, which will help the company take full advantage of the current favorable market conditions. While Goldcorp merely matches Silver Wheaton's 1.2% dividend yield, its ability to make smart acquisitions, increase its production, and lower its costs speaks well of its ability to raise its yield in the future.

Yamana Gold has only a 1.3% dividend yield, but its five-year dividend growth rate is a solid 67%. It has also grown its revenues in four of the past five years. In addition, its costs for gold production are below $100 per ounce, which is an improvement even on Barrick Gold's and Goldcorp's low costs. In fact, Yamana's Chapada mine in Brazil produces copper and other byproducts that take down the costs of production per ounce of gold to less than 0. While Yamana has not tied its dividend to the prices of metal as Hecla Mining and Newmont Mining have, it has paid out more of its profits to shareholders.

Agnico-Eagle's decision to shut down its Goldex mine resulted in declines of 20% in the share prices on the day it was announced, but the decision demonstrated the integrity of the company's leaders, who were unwilling to risk the lives of their underground personnel for the 1.6 million ounces of gold that remained -- a decision that came after a rock-mechanics consulting firm indicated that the failure of the mine's hanging wall caused groundwater to enter the mine, which led to movement and weakness in the rock. There are other reasons to like Agnico-Eagle other than its displays of integrity: The company has a 9.2% stake in Rubicon Minerals (AMEX: RBY  ) and its acquisition of Grayd Resource should give it access to some useful development assets. It also offers a modest 1.6% dividend yield.

Using the DuPont formula can often give you some insight into how a company is competing against peers and what type of strategy it's using to juice return on equity. To find more successful investments, dig deeper than the earnings headlines.

Because commodities prices are volatile, buying these stocks for the dividends might be fraught with peril. Instead, you may want to increase your dividend yield by investing in companies with strong track records for large and growing payouts. If you'd like to explore more dividend investment opportunities, check out our free report, Secure Your Future With 11 Rock-Solid Dividend Stocks. It's available free for a limited time. Get your copy.

Jim Royal, Ph.D., owns no shares in any company mentioned. 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.


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