Published February 18, 2017

Weekend Edition: If You Want to Double the S&P 500, Do This First

Justin's note: Over the next few days, we’ll be sharing a special three-part series from our friend Nick Rokke with you. Nick is the editor of The Palm Beach Daily, a chartered financial analyst (CFA), and one of the smartest investors I’ve ever met.

In this must-read series, Nick’s going to explain how he finds great stocks. As you’ll see, this simple method could help you crush the market in the coming years. On Tuesday, we’ll return to our regular market commentary.


Today, I’m going to share a little-known stock-picking method with you…

It’s a system that would have allowed you to double the returns of the market over the past 20 years.

Wall Street doesn’t want you to know about this method because you’ll be able to pick stocks yourself without its help.

Let me explain…

Most brokers want you to blindly put your money into their index funds. The more people they put into these funds, the more money they make (regardless of performance).

Plus, index funds are easier for them to manage. They don’t have to put in the work to find great companies for you.

But our goal at The Palm Beach Daily is to help the average Joe become a world-class investor. We’ve put in hundreds of man-hours to bring the best research to our readers.

That’s why, today, I’m sharing my simple three-step stock-picking method for picking elite companies.

These elite companies returned 21.6% per year over the past two decades. The S&P 500 returned only 7.4% (including dividends) during the same span.

If you invested $1,000 in the S&P 500 Index in 1997, it would have turned into $4,200 today.

If you put the same $1,000 in our elite class of companies, it would have grown to $50,200. That’s 12 times more money. And this difference grows bigger every year.

Fortunately, our method makes it much easier to identify these types of companies.

It only takes a few minutes to learn. And once you do, you’ll be able to pick elite companies yourself…

Your Checklist for Finding Elite Companies

There are three things we look for when trying to identify elite companies:

  1. High return on invested capital (ROIC)

  2. High growth

  3. Cheap valuations

Today, I’ll you show you how to use Step 1 (high ROIC) to create a shortlist of elite companies you can choose from.

I’ll go over Step 2 (high growth) tomorrow and conclude with Step 3 (cheap valuations) on Monday.

By the time we’re finished, you’ll know how to identify a handful of elite companies that will make you lots of money.

The Best Way to Find Profitable Companies

The first box you need to check on the list is high ROIC.

ROIC is calculated by subtracting taxes from operating profits and then dividing the result by invested capital.

I like ROIC better than the more commonly used “net income” metric because it doesn’t include one-time charges and write-offs.

It’s also a more consistent measure of profits than net income.

ROIC is always calculated as a percentage. Good companies have an ROIC of over 10% per year.

But here’s what separates the elite from the good: Elite companies have an ROIC of 20% or more year after year after year…

The “year after year after year” part is important.

A company that achieves a 20% ROIC for one year might be a fluke. But if a company averages a 20% ROIC for at least five years in a row, it’s likely an elite business.

As you can see in the chart below, companies with an ROIC of 20% or higher have doubled the returns of the S&P 500 over the past 20 years.

The High-ROIC Shortlist

There are more than 4,200 publicly listed U.S. companies with market caps of $200 million or more.

We were able to filter those down to 281 by just looking at those with an average ROIC of over 20% over the past five years.

To narrow it down even more, we scanned the list for companies with the highest average ROIC over the past five years. That pinpointed 10 (see table below).

  Company Name Ticker Average ROIC
(5-year)
  Fifth Street Asset Mgmt. FSAM 993%
  Aspen Technology AZPN 694%
  Moelis & Company MC 216%
  Natural Health Trends NHTC 182%
  Terra Nitrogen TNH 156%
  Vonage Holdings VG 117%
  Marriott International MAR 109%
  Avid Technology AVID 97%
  Domino’s Pizza DPZ 75%
  CBOE Holdings CBOE 70%

Now, just because these companies made our high-ROIC shortlist doesn’t necessarily mean they’ll make elite status…

Remember, there are two other boxes to check on our list: high growth and cheap valuations. But this list is a good starting point to find quality companies.

Tomorrow, we’ll winnow this list down to four of the best performers over the past five years. By Monday, only one elite superstar will be left…

Regards,


Nick Rokke, CFA 
Analyst, The Palm Beach Daily