How Well Do You Use Cash, Green Mountain Coffee?

There are two parts to successful investing: finding the winners and avoiding the losers.

But looking just for the former, especially if you focus mostly on revenue and earnings, can leave you exposed to the latter.

To fully benefit from your winners, you need to spot the ones to stay away from. After all, a 200% gain is completely wiped out by four other picks dropping 50% each. As for that winner, revenue and earnings are not the place to see trouble coming in time to do some good. You don't want to wait for an ugly earnings surprise that gives your stock a massive haircut before getting out.

That's why just about the first thing I read is the balance sheet. This is where the company's financial health is found and where sickness' warning signs often show up.

One balance sheet tool I like is the cash conversion cycle (CCC). This shows how fast the company turns its cash into inventory, sells that inventory, and then collects the cash on those sales. It's measured in days and, generally, the lower it is, the better. (For details on how it's calculated, check the Foolsaurus investing wiki entry here.) It is possible to have a negative CCC, as Dell showed to great effect for several years. Seeing CCC increase can mean it's a company to avoid or exit.

This metric doesn't apply to every industry, however, such as banks. It's primarily for companies that interact with suppliers and customers, buying from one, selling to the other.

Here are three companies operating in the same industry that recently caught my eye:

Company

CCC (TTM)

1-Year Change

3-Year Change

5-Year Change

Green Mountain Coffee Roasters (Nasdaq: GMCR  )

59.1

2.7

16.5

18.3

Starbucks (Nasdaq: SBUX  )

36.5

(6.0)

(4.2)

(13.1)

Peet's Coffee & Tea (Nasdaq: PEET  )

31.8

2.2

2.5

8.2

Source: Capital IQ, a division of Standard & Poor's, and author calculations. TTM = trailing 12 months. All numbers are in days.

Of the three, Green Mountain is the worst. Its cash cycle is nearly twice that of Peet's and, unlike Starbucks, Green Mountain's cycle has been increasing. True, it's a much smaller company than Starbucks, but it is much larger than Peet's, so size alone cannot be an excuse. If management doesn't start to rein this in, shareholders could end up in trouble.

Of course, the cash conversion cycle should not be the end of your research, and it's best to follow trends over time. However, it can provide useful pointers to either getting in or staying away.

Go past the obsessive focus on quarterly earnings and you'll be way ahead of the vast majority of the market's individual investors. By learning to calculate and use the cash conversion cycle, you'll more likely spot a deteriorating situation early enough to either avoid the company in the first place or get out before the company "surprises" with a bad earnings report.

Green Mountain Coffee Roasters is a Motley Fool Rule Breakers selection. Starbucks is a Stock Advisor pick. Try any of our Foolish newsletter services free for 30 days.

Fool analyst Jim Mueller, who works with the Stock Advisor newsletter service, owns shares of Starbucks, but not of any other company mentioned. The Fool's disclosure policy has cycled through the company three times while you read this article, showing off on a unicycle.


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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 August 19, 2010, at 5:08 PM, cmyersvt wrote:

    thanks for the analysis. As a new investor I am always to look at the process from a new perspective and I love discussion of new metrics. However, doesn't the way the company use cash affect the analysis? for example in the past 12 months Green Mountain has purchased a number of companies for various reasons. As a result, their cash doesn't go directly to replace inventory but into longer term investments which will hopefully pay off. I believe according to your framework, this wwould only be reflected in later CCC calculation if they are successful but may be an indicater tha more analysis is necessary before making a don't buy decision now. Am I on target?

  • Report this Comment On August 20, 2010, at 4:49 PM, Mstinterestinman wrote:

    In my opinion the reason why the arent creating much free cash is they are in hypergrowth mode aggresively expanding their footprint and buying out smaller competitors. They pretty much control the specialty coffee market so I expect solid improvement in caswh flows and cash usage over the next 12 months.

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