As an investor, 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 Crocs
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
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 four industry peers over a few periods.
Company | Cash King Margin (TTM) | 1 Year Ago | 3 Years Ago | 5 Years Ago |
---|---|---|---|---|
Crocs | 7.9% | 10.1% | (0.5%) | (3.7%) |
Cherokee | 33.5% | 41.5% | 43.2% | 42.5% |
Skechers | (5.9%) | (2.3%) | 0.9% | 0.8% |
Quiksilver | (1.8%) | 8.5% | (0.8%) | (4.7%) |
Source: Capital IQ, a division of Standard & Poor's.
Of these companies, only Cherokee
Crocs gained notoriety for its classic rubber shoes, which earned the company 62% of its revenue in 2006. When this fad declined, the company faced an epic collapse, after which it began to search for ways to avoid over-dependence on the continued popularity of a single product. To this end, it has developed a new line of golf shoe, and a line of children's shoes marketed to back-to-school shoppers. However, Crocs continues to face plenty of competition from other shoe companies like Nike
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 Crocs? Add it to My Watchlist, which will find all of our Foolish analysis on this stock.
- Add Quiksilver to My Watchlist.
- Add Under Armour to My Watchlist.
- Add Skechers USA to My Watchlist.
- Add Nike to My Watchlist.
- Add McDonald's to My Watchlist.
- Add Deckers Outdoor to My Watchlist.
- Add Crocs to My Watchlist.
- Add Cherokee to My Watchlist.