Investors in gold have had a very painful four years, with the price of the yellow metal plunging 39% off of its 2011 high.
Due to this bear market, several popular gold stocks, including Newmont Mining (NYSE:NEM), Barrick Gold (NYSE:ABX), and Royal Gold (NASDAQ:RGLD), have badly trailed the S&P 500 over the past five years or even lost substantial value.
Yet there are two major reasons to believe Royal Gold -- which I consider to be one of America's best gold stocks -- has the potential to not only continue to outperform its competitors, but even to beat the market in the long term. Both reasons are based on the company's superior business model, which should put it at the top of every gold investor's watchlist.
Business model makes sales growth easy, even in a gold bear market
Royal Gold is a gold royalty streamer meaning that it serves as a kind of financier to gold miners. In exchange for an up-front cash payment, which mining companies use to increase production or develop mines, it secures the royalty streaming rights to a fraction or stream of a miner's production. Most of the time it is able to secure these streaming rights at substantial discounts to the current gold price, such as its recent average cost of $578 per ounce. This deeply discounted gold cost allows Royal Gold to achieve exceptional margins. For example its gross margin in the first 3 quarters of 2014 was 55%.
Because Royal Gold's production is derived from a portfolio of royalty streams, as opposed to its own physical mine, it is able to achieve impressive revenue growth even when gold prices are falling merely by growing its streaming portfolio. For example, in the last six months of 2014 its sales grew by 19.2% compared to the same period a year earlier.
In 2015 Royal Gold expects its diversified portfolio of 201 production, development, and exploration properties, to achieve year-over-year gold production growth of 20% to 30%. Thus, even if the price of gold remains at its current level or declines further, the company is likely to grow its sales -- without need for expansion of overhead costs.
Business model makes long-term margin expansion possible, especially after a gold bear market
Royal Gold's most exciting prospect is in the long-term potential for it to strengthen its market position. That's because the fall in the price of gold, along with a greatly increased cost of gold mining in recent years, has left many miners with falling margins and depleted cash positions.
In contrast Its low-cost business model has enabled Royal Gold to strengthen its balance sheet, and today the company sits atop a total liquidity position of nearly $1.2 billion.
In capital-intensive industries such as mining, a downturn is a great opportunity for those with plenty of liquidity to exact preferential terms from those in need of cash. So the longer the downturn in gold lasts, the larger the discounts Royal Gold could obtain for its streaming rights. Given the long-term nature of such contracts, when gold prices eventually recover, Royal Gold's margins should expand, growing its cash flow and allowing it to continue its impressive dividend growth track record -- which studies show is one of the most important criteria for long-term market outperformance.
Takeaway: Royal Gold's business model makes it one of the few gold stocks worth owning, no matter what gold is doing
Royal Gold's royalty streaming business model is the only one I would recommend long-term investors choose if they wish to diversify their portfolios into gold. It produces not only low overhead costs and high margins, but also allows for faster sales growth and even long-term margin expansion once gold prices eventually recover. Throw in a long-term track record of consistent dividend growth, and it is easy to see why I think all gold investors should consider Royal Gold for a spot in their diversified portfolios.
Adam Galas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.