Silver is unique among precious metals because it's important for its industrial value as well as for its ability to hold wealth. Industrially, silver is used in a number of applications, including photographic film, solar panels, water filtration, X-rays, and energy-efficient windows, among many other usages. In 2014, industrial uses accounted for 56% of silver's demand. The rest of the demand comes from silver's value as a holder of wealth, including its use in jewelry, silverware, coins, and bars.
Most investors tend to view silver in the light of its ability to hold wealth and invest in it with the thesis that the price will increase in value over time. It's why investors pour money into silver exchange-traded funds that hold the physical metal in storage. While the price of silver has certainly increased over time, its volatility has obliterated the wealth of investors who bought at the top of its two previous price peaks.
This volatility is why investing in stocks that just own silver doesn't always pay off. On the other hand, silver mining companies, which make money by selling the silver they produce, can deliver leveraged gains by growing their silver production over the years. Of that group, there's one silver stock that really shines above the rest.
Shining a light on the silver stream
Like most silver mining companies, Silver Wheaton (NYSE:SLW) makes its money on silver that's produced out of mines. However, its business model is a bit different, because it doesn't own any silver mines. Instead, it invests in a new mine by providing a miner cash that it uses to develop the resource. In return, Silver Wheaton receives the right to purchase future silver and/or gold produced from that mine at a fixed price. That business model gives Silver Wheaton investors several advantages that they wouldn't enjoy if they simply invested in a silver mining company:
The key points from that slide are that Silver Wheaton investors get 100% exposure to the upside of the silver price. That upside comes with much less risk, as Silver Wheaton's silver is acquired at a fixed cost and without the risk of being exposed to the typical cost overruns associated with developing new mines. Further, because the company is selling silver instead of holding it in a vault, those sales are generating cash flow, a portion of which Silver Wheaton sends back through dividends.
Because of this model, Silver Wheaton generates really great margins. As the following slide notes, the company buys silver for just over $4 per ounce, which gives it really strong margins in virtually any silver price environment.
These margins drive strong cash flow generation, 20% of which is sent back to investors through dividends.
However, beyond the tangible return from dividends, Silver Wheaton also offers investors visible growth even if the price of silver stays stagnant, because the company continues to invest in new silver projects, which will boost its silver streaming income in the years ahead. As this next slide shows, the company expects its production to grow by 40% over the next few years as new mines come online.
This high-margin production growth will lead to increased value for investors, even if the silver price is flat to slightly down, which is wealth creation that investors in physical silver won't enjoy.
Investors looking to invest in silver can do much better than simply holding the physical metal. That's because silver streaming company Silver Wheaton offers investors upside to the price of silver as well as growth and income from increased silver production. Better yet, investors get all this upside without the downside to cost inflation that has plagued mining companies over the years.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of Silver Wheaton (USA). 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.