Justin's note: Today, we're continuing Palm Beach Daily editor Nick Rokke's three-part series on identifying elite companies. As Nick explained yesterday, this little-known stock-picking system would have allowed you to double the returns of the market over the past 20 years.
Below, he reveals Step 2...
Words can’t describe what I’m about to show you today…
Just look at this chart.
You see the green line… If you want to ride it, read on…
Reviewing Our Three Steps
In yesterday’s essay, I shared with you my three-step method for identifying elite companies. Here’s the checklist again:
High return on invested capital (ROIC)
The first step of our method is to find companies with a high ROIC. That measures a company’s profitability… and how efficiently it turns long-term assets into money.
A company making an ROIC of 20% per year for at least five years in a row is a good candidate for elite status.
By applying just that first step, you’d double the returns of the S&P 500 over the past 20 years. That’s the blue line above.
Yesterday, we showed you 10 companies that ticked the first box.
But if you really want to get on the green line and quadruple your gains, you need to move on to Step 2. I’ll show you how to do that today…
The Next Step to Increase Your Gains
As we explained yesterday, just because a company has a high ROIC one year doesn’t mean it’s elite. It may be a fluke. Or shady accounting. Or some other transitory reason.
In fact, some companies with the highest ROICs over the past five years have been bad investments.
To avoid duds, we need to move to Step 2: broad-based growth.
We want to see an increase in revenues, free cash flow, and gross margins.
This assures that the company isn’t losing its edge by aggressively expanding. Some companies grow revenue but at the expense of profits. That’s not always a good business decision.
To Pump up Returns, You Need Growth
We started with over 4,200 publicly listed U.S. companies with market caps over $200 million.
We were able to narrow that to 281 by looking at companies with more than 20% ROICs over the past five years.
Of those 281, we were able to select 10 with some of the highest ROICs since 2012.
We filtered the 10 companies by growth… and only four stood out (highlighted in green in the table below): Aspen Technology, Natural Health Trends, Marriott International, and Domino’s Pizza.
|Company Name||Ticker||Average ROIC
|Fifth Street Asset Mgmt.||FSAM||993%|
|Moelis & Company||MC||216%|
|Natural Health Trends||NHTC||182%|
Each passed all three of our growth tests (revenues, free cash flow, and gross margins).
These are some of the highest-quality companies around over the past five years.
If you filtered for just ROIC and growth, you would beat 99% of investors. These companies crush the market.
But we’re still one step away from finding the best-of-the-best investments. On Monday, I’ll show you which company could have really catapulted your investment returns.
Nick Rokke, CFA
Analyst, The Palm Beach Daily