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 The Coca-Cola Company (NYSE:KO) 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 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 Corporation (NYSE:MCD) as an example. In the four quarters ending in December, the restaurateur generated $6.97 billion in operating cash flow. It invested about $3.05 billion in property, plant, and equipment. To calculate free cash flow, subtract McDonald’s investment from its operating cash flow. That leaves us with $3.92 billion in free cash flow, which the company can save for future expenditures or distribute to shareholders.
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 14% — a nice high number. In other words, for every dollar of sales, McDonald’s produces $0.14 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.
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|
|Dr Pepper Snapple||4.4%||9.2%||9.9%||6.5%|
While Coke exceeds our 10% threshold for attractiveness by more than six percentage points, none of these other companies meets the mark. However, PepsiCo, Inc. (NYSE:PEP) isn’t far from meeting the standard, with cash king margins of 8.8%. However, both Coke and Pepsi have cash king margins below what they were five years ago, as they’ve acquired bottlers. Dr Pepper Snapple Group Inc. (NYSE:DPS)‘s cash king margins are less than 5%, but the company offers a 3.5% dividend yield, while Coke and Pepsi both have yields below 3%. Sodastream International Ltd (NASDAQ:SODA)‘s cash king margins are below 1%. It has also seen massive fluctuation in its margins over the last five years and doesn’t yet offer a dividend.