Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.

Is Mead Johnson Nutrition a Cash King?

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 Mead Johnson Nutrition (NYSE: MJN  ) 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 in December, the restaurateur generated $7.15 billion in operating cash flow. It invested about $2.73 billion in property, plant, and equipment. To calculate free cash flow, subtract McDonald's investment ($2.73 billion) from its operating cash flow ($7.15 billion). That leaves us with $4.42 billion in free cash flow, which the company can save for future expenditures or distribute to shareholders.

Taking McDonald's sales of $27.0 billion over the same period, we can figure that the company has a cash king margin of about 16.4% -- a nice high number. In other words, for every dollar of sales, McDonald's produces more than $0.16 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:

Cash King Margin (TTM)
1 Year Ago
3 Years Ago
5 Years Ago
Mead Johnson Nutrition 14.2% 10.9% 14.2% NA
J.M. Smucker 3.7% 9.8% 5.5% 10.3%
Herbalife 12.1% 11.7% 7.8% 6.5%
ConAgra Foods 6.4% 6.9% (4.2%) 1.1%

Source: S&P Capital IQ.

Mead Johnson Nutrition and Herbalife (NYSE: HLF  ) both meet our 10% threshold for attractiveness, but while Mead Johnson has failed to grow its margins from three years ago, Herbalife's are up more than 4 percentage points. ConAgra (NYSE: CAG  ) has also grown its margins from three years ago, but its current margins are several percentage points away from our 10% threshold. J.M. Smucker (NYSE: SJM  ) has the lowest cash king margins of the listed companies, and its current margins are the lowest they have been in these four periods. Compare these returns to the blue chips of software and biotech, to get some context.

Mead Johnson, which specializes in infant and child nutrition products, was spun off from Bristol-Myers Squibb (NYSE: BMY  ) in 2009. Mead has significant exposure to Latin American and Asian emerging markets, gaining more than 60% of its revenues from those areas. Since then, the company has been in such high demand from shareholders that Bristol-Myers decided to get rid of its remaining ownership stake and Pfizer has considered also selling or spinning off its own nutrition business.

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 Mead Johnson Nutrition? Add it to My Watchlist, which will find all of our Foolish analysis on the stock.

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

Read/Post Comments (0) | Recommend This Article (0)

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.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1856166, ~/Articles/ArticleHandler.aspx, 3/29/2015 5:25:17 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...