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 Las Vegas Sands (NYSE: LVS ) 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 $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.
Four companies
Here are the cash king margins for four industry peers over a few periods.
| Las Vegas Sands | 14.5% | 12.3% | (31.9%) | (116.3%) |
| MGM Resorts (NYSE: MGM ) | 5.5% | 5% | 7.6% | (25%) |
| Melco Crown Entertainment (NASDAQ: MPEL ) | 17.9% | 17% | (78.9%) | (146.8%) |
| Wynn Resorts (NASDAQ: WYNN ) | 18.3% | 25.3% | 1.7% | (13%) |
Source: Capital IQ, a division of Standard & Poor's.
Las Vegas Sands exceeds our 10% threshold by nearly 5 percentage points, and has offered significant growth in its cash king margins over the past five years. It also offers a 1.9% dividend yield. Like Sands, Melco has shown great growth in free cash flow, following some buildouts of its properties. Wynn offers even higher margins at 18.3%, and also offers significantly higher margins than it had five years ago. It also offers an even higher dividend yield than Las Vegas Sands, at 3.3%. However, its margins have declined significantly from last year. MGM only offers 5.5% margins, which are much higher than what they had five years ago, but its margins are currently more than two percentage points lower than they were three years ago. Neither MGM nor Melco offer dividends.
While Las Vegas Sands has a strong foothold in its home territory, it has managed to show impressive growth in Macau. However, the company has faced heavy competition from Melco and Wynn. Further, all of these companies have struggled to keep up with past growth trends due to the struggling Asian economy. Las Vegas Sands' choice not to expand into online gaming may also cause it to face domestic challenges if online gaming becomes legal. While these companies have faced struggles in Macau, however, their international exposure has helped shield them from the dramatic reductions in Vegas gambling in recent years. MGM Resorts, however, has not been so lucky.
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.
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