Streetwise

Lauren Rudd

Sunday, April 1, 2012

A Funny Thing Happens on the Way to Wall Street

Before you decide to become a card carrying member of the Chicken Little league, as a result of listening to the soothsayers of doom, consider that a funny thing happens on the way to Wall Street. Stocks over time outperform other investments, period.

The key reason is that businesses retain earnings, which are reinvested to generate additional earnings and higher dividends. Driving it all is the basic theory of compounded return. This was pointed out as far back as 1924 with the publication of a slim little book titled “Common Stock as Long Term Investments,” written by Edgar Lawrence Smith.

Legendary economist John Maynard Keynes, in reviewing the book, was quick to delineate that most important point. Keynes wrote, “Well-managed companies generally do not distribute to shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back in the business. Thus, there is an element of compound interest operating in favor of a sound industrial investment.”

Yes, it is no secret that the players on Wall Street have often lined their own pockets at the expense of their clients. Not to ruin your day but the financial markets have always been driven by greed and a liberal interpretation as to what denotes fair play.

However, the Street’s antics should never be an impediment to your building a portfolio. So where do you start? Well you could pour yourself a glass of suds as you wait for the gods of chance to look favorably upon your lottery ticket. Or you can begin by looking for companies that show a symbiotic relationship with an expanding economy. A good example is Southern Copper (SCCO).

The Company is an integrated copper producer with the industry’s largest copper reserve. It operates mining units and metallurgical facilities in Mexico and Peru and conducts exploration activities in Argentina, Chile, Ecuador, Mexico and Peru.

Activities include mining, milling, and flotation of copper ore to produce copper and molybdenum concentrates; smelting of copper concentrates to produce anode copper; and refining of anode copper to produce copper cathodes, as well as refined silver.

Looking at Southern’s financial results for 2011, sales were a record $6.82 billion, a gain of 32.4 percent over the previous year. This was the result of both higher copper sales and higher copper, silver and zinc prices.

Earnings before interest, taxes, depreciation and amortization (EBITDA) were a record $3.9 billion, with a gross margin of 57.3 percent, as compared to 55.6 percent in 2010. At the same time, net income was also a record $2.34 billion, an increase of 50.3 percent when compared with the previous year. Net income represented 34.3 percent of total revenues.

Copper production increased 22.8 percent, when compared with a year ago, and was mainly the result of higher production at the Buenavista mine, which is currently working at 100 percent of capacity. However, an aggressive investment program for this property will increase capacity to 488,000 tons of annual copper production by 2015, a 170 percent increase.

Total copper production for 2011 was 638,810 tons. The operating cost per pound of copper, before by-product credits, was $1.66, as compared with $1.52 per pound in 2010. The operating cost per pound net of by-products was $0.41, making Southern Copper one of the lowest cost producers in the industry. Capital expenditures of $612.9 million, also a record, represented 26.2 percent of net income.

A discounted earnings model yields an intrinsic value of $77 per share utilizing a 15 percent discount rate and a 15.7 percent growth rate, while the more conservative free cash flow to the firm model suggests an intrinsic value of $93 per share, using a discount rate of 9.39 percent, which is the company’s weighted cost of capital. The shares recently closed at $31.70.