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SASKATOON, Saskatchewan (
) -- After reaching their apex in June 2008, shares of
have fallen by more than half.
The companies offered exposure to a market that would certainly factor into the ongoing global expansion. Fertilizer producers' growth was projected to go into orbit as the world figured out a way to produce enough food to feed emerging super powers such as China and India.
While growth petered out during the economic contraction of the past year, these companies still appear to be well-positioned to profit from globalization. Potash and Mosaic are beating the S&P 500 this year. Potash has climbed 32%, while Mosaic is up 54%, versus the S&P 500's increase of only 13%.
Deciding between those investments can pose a more difficult decision for investors than simply whether the industry looks attractive in the current economic climate. Both Mosaic and Potash have appealing metrics underpinning them. However, when looking at the complete picture, one is a clear favorite.
Both Potash and Mosaic offer betas of greater than 1, suggesting the stocks will be more volatile than the market as a whole. While this could be troubling for investors seeking a low-risk portfolio to protect capital, investors who desire greater growth opportunities should be interested by these numbers. During these times of great economic uncertainty, many investments have beta values well in excess of 2. These relatively modest figures promise that both investments should offer controlled movement.
Capital Asset Pricing Model
The output of the capital asset pricing model implies that investors should require a greater return on an investment in Mosaic than for Potash. This is due directly to the added risk from the higher beta value of Mosaic. The premium needed for an investment in Mosaic has been more than satisfied as it has out-climbed Potash by more than 20% this year.
Potash shines here with sustainable growth of nearly 40%. This is due to Potash's superior return on equity, since both firms retain nearly all of their earnings by paying meager dividends. While Potash's performance is impressive, factors such as free cash flow and the accruals ratio, discussed below, make recent performance seem unsustainable.
Potash appears to have a more substantial residual income. However, when comparing these amounts to the share prices, it becomes apparent that Potash is trading at a premium over Mosaic in terms of residual income. The price to residual income for Potash is 16.2, while Mosaic is at 14.6, suggesting a cheaper investment opportunity.
Here, again, Mosaic trumps Potash, offering investors a 3.7% return for every unit of risk in the holding. While Potash also offers decent compensation of 2.4% for every unit of risk, Mosaic is clearly superior. This is a crucial metric to determine whether an investment adequately compensates investors. Mosaic is very attractive, according to the Sharpe ratio.
Free Cash Flow to Equity
Even though Potash boasts a bigger return on equity, Mosaic enjoys a stronger free cash flow to equity position. This additional cash flow will allow Mosaic to deploy capital at a far greater rate than Potash, allowing it to exploit cheap prices for expansion and improvement in the recession. Despite the weightier sustainable growth figure for Potash, Mosaic has brighter options. This metric adjusts for accounting movements that can skew results of return on equity and sustainable growth.
The accruals ratio further proves that Mosaic is a safer bet. With a lower accruals ratio, Mosaic appears to have less performance coming from unsustainable accounting gimmicks. While both companies offer fairly low accruals ratios, Mosaic, as the lower of the two, appears stronger when adding the positive effects of its meaty free cash flow.
Present Value of Growth Opportunities
While Potash supposedly has a higher sustainable growth rate, using the PVGO measure, we can see that much of this extra growth has already been priced into the shares of Potash. With 56.9% of its share price coming from growth opportunities, it will be difficult for investors to profit much from the growth when it materializes. Mosaic, on the other hand, has less growth priced in and, according to the above breakdown of free cash flow and the accruals ratio, a much greater probability of excess growth going forward.
Mosaic and Potash will both likely profit from the economic turnaround when an expansion resumes. However, Mosaic, rather than Potash, is the best bet for investors to profit from this movement. Mosaic is priced right with a strong fundamental basis to take off from.
Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level II CFA candidate.