Is Gold a Good Addition to Your Portfolio?

Gold can help diversify your portfolio. However, it doesn’t generate any income.

I believe that Franco-Nevada (TSX:FNV)(NYSE:FNV) is a superior investment to gold. The company is primarily a gold royalty and streaming company with a large and diversified portfolio of assets. Further, it offers a yield of about 1.3%, and it has been increasing its dividend every year.

Image source: Getty Images

As explained on Franco-Nevada’s website, royalties are ongoing economic interests in the production or future production from a property, while streams are metal purchase agreements that provide, in exchange for an upfront deposit, the right to purchase all or a portion of one or more metals produced from a mine at a preset price.

So, Franco-Nevada is a low-risk, high-margin business. Its balance sheet is clean with no long-term debt, and its recent net margin was 31.8%.

Outperforms in total returns

Franco-Nevada stock tends to outperform the market. From right before the last recession in 2007 to now, the stock has delivered an annualized rate of return of about 19.1%, which greatly outperformed the returns of 6.5% of the U.S. market (using S&P 500 as a proxy) in the period. Notably, the U.S. market generally outperforms the Canadian market or the TSX Index. So, you can assume that Franco-Nevada stock tends to outperform the TSX Index, too.

FNV data by YCharts. The long-term price action of  TSX:FNV, SPY, and TSX:XIU, representing the Canadian market.

Since 2012, Franco-Nevada stock’s annualized rate of return has been 14.6%, which outperformed the U.S. market returns of 12.5%. Now, of course, there are periods in which the U.S. market beat Franco-Nevada. It goes without saying that investors should always aim to buy the stock at a discount — at least as it pertains to Franco-Nevada’s unique situation, as explained in the next section.

Franco-Nevada is always expensive

The problem with Franco-Nevada is that it always tends to trade at a premium valuation. As of writing, it trades at a price-to-earnings ratio (P/E) of over 60, while its five-year P/E is more than 190!

Let’s compare its other valuation metrics. Its price-to-operating-cash-flow ratio (P/OCF) is about 26.5, while its five-year P/OCF is about 29.9. Its price-to-book ratio (P/B) is about 2.8, while its five-year P/B is about 2.7. These valuation metrics indicate that the stock is slightly undervalued to being fairly valued.

Investor takeaway

Franco-Nevada is an intriguing investment that maintains a premium multiple because it has a large and diversified portfolio of assets, which will only become larger and more diversified over time as it adds new streams and royalties.

I think the best valuation metric to look at for an entry point in Franco-Nevada is its price-to-operating-cash-flow ratio, which indicates the stock is slightly undervalued.

Alternatively, for a simpler investing method, aim to buy the stock on meaningful dips and average into a position over time as a quality addition to your portfolio for diversification purposes.

Analysts from Thomson Reuters have a 12-month mean target of US$81.40 per share on Franco-Nevada, which indicates near-term upside potential of about 10%.