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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 Manitowoc (NYSE: MTW ) 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 actually 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.
Here are the cash king margins for Manitowoc and three industry peers over a few periods.
Cash King Margin (TTM)
1 Year Ago
3 Years Ago
5 Years Ago
|Illinois Tool Works (NYSE: ITW )||7.4%||9%||12%||11.1%|
|Cooper Industries (NYSE: CBE )||6.8%||7.7%||11.9%||11.2%|
|Terex (NYSE: TEX )||(5.7%)||(14.6%)||2.3%||4.9%|
Source: S&P Capital IQ.
Manitowoc's cash king margins have declined by nearly 7 percentage points from five years ago, and are currently in the negative numbers. The highest performer in the group is Illinois Tool Works, with current margins at 7.4%. However, its margins have also declined from five years ago, as have the margins of its industry peers.
Manitowoc is involved in two very different businesses -- making cranes for industrial construction projects and producing equipment for food-service providers. While the construction industry has been suffering during the recession, Manitowoc's involvement in emerging markets has helped the company continue to bring in business, and this business does not show signs of slowing down in 2012. Also, last year, McDonald's recognized that Manitowoc's frymaster line would help it reduce its carbon footprint. Yum! Brands is also a major customer, which will help Manitowoc take advantage of growth in food services business in emerging markets. On the downside, the company only offers a 0.8% dividend.
Illinois Tool Works offers a lot of what conservative investors are looking for, with a 3% dividend yield and a payout that has increased 48 years in a row. The company's stock price took a beating this quarter, when the company announced earnings that exceeded analyst estimates but also predicted disappointing future earnings. If investors are willing to wait for things to turn around, this could be a good buying opportunity. With a five-year average dividend growth rate of 14.4%, consistent dividend increases, and fairly consistent revenue growth, Illinois Tool Works has established a strong track record for success.
Cooper Industries specializes in electronic products. The company recently announced that it will acquire Changzhou Yuhua Electrical Equipment manufacturing, Blinda Industria e Comercia, and GE's Industrial Systems British Standard fuse-link product portfolio. According to chairman and CEO Kirk S. Hachigian, this move is linked to an effort to extend the company's business further into emerging markets. Cooper also offers a 2.2% dividend yield.
Terex produces equipment for a wide variety of industries, including construction and refining equipment. Unfortunately, its customers have all suffered during the recession, resulting in a lack of money to pay for Terex's products. Also, because Terex does not produce farm equipment, it has not benefitted from the increase in crop prices that has benefitted other equipment produces like Deere (NYSE: DE ) and Caterpillar. However, Terex managed to gain some money by selling its mining unit to Bucyrus before it was taken over by Caterpillar. As long as the economy continues to struggle, it is likely that Terex will struggle as well, and does not provide shareholders with a dividend to tide them over in the meantime. However, once the economy rebounds, Terex could produce some nice gains for investors.
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.
While modest dividends are nice, 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 free copy.