Zacks Investment Ideas feature highlights: Wal-Mart, Apple, Autozone, Varian Medical and Dollar Tree
CHICAGO, Dec. 5, 2012 /PRNewswire/ -- Today, Zacks Investment Ideas feature highlights Features: Wal-Mart (NYSE: WMT), Apple (Nasdaq: AAPL), Autozone Inc (NYSE: AZO), Varian Medical (NYSE: VAR) and Dollar Tree Inc (Nasdaq: DLTR).
The Best Businesses to Own
In his Annual Letter to Shareholders in 1992, legendary investor Warren Buffett stated the following:
"Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the opposite - that is, consistently employ ever-greater amounts of capital at very low rates of return."
So how do you know how well a company is employing its capital? Look at its Return on Invested Capital.
Return on Invested Capital (ROIC) is calculated as:
Net Operating Profit After Taxes / Invested Capital
Invested capital is broken down further as Total Assets - Excess Cash - Non-Interest-Bearing Current Liabilities.
An ROIC of 15% means that for every $1 of capital invested in a business, 15 cents of after-tax income was created during that period. The best companies generate returns above their weighted average cost of capital (WACC).
The weighted average cost of capital is the minimum return required to satisfy all investors, including creditors and shareholders.
Companies with ROIC greater than their WACC are creating value for their owners. They are earning superior risk-adjusted returns for investors and generating positive economic profits.
On the other hand, companies with ROIC below their cost of capital are destroying value for shareholders. They are earning returns below what the market requires for assuming the risk of investing in the company.
EPS Growth Does Not Equal Value Creation
It is important to note that just because a company is growing its earnings per share doesn't mean that the growth is profitable.
Assume a company dumps $1 billion of capital into a project that generates $50 million of earnings next year. Sure earnings grew, but it produced a return of just 5%. That $1 billion in capital would have been better used elsewhere.
Conversely, if the company can generate $50 million in earnings from an investment of, say, $250 million, that's a much better 20% return.
Protect the Castle
If a company or an entire industry is consistently generating returns well above its cost of capital, you can be sure that this will attract some competition. Entrepreneurs will seek to enter the industry in an attempt to capture some of the outsized returns.
In order to fend off this competition and sustain positive economic profits, a company needs to have some sort of durable competitive advantage, or "moat".
Competitive advantages can come in many different forms, most of which fall into two different categories: cost advantage and differentiation advantage.
The cost advantage is a company's ability to produce a good or service at a lower cost than the competition. Think Wal-Mart (NYSE: WMT).
The differentiation advantage is created when a company's products or services are perceived as superior by customers. Think Apple (Nasdaq: AAPL).
The wider a company's "moat", the more effective it will be at fighting off competitors.
One of the best ways to determine a company's moat is to measure its Return on Invested Capital. A true wide moat business will have stable or growing ROIC.
Profitable Growth at a Reasonable Price
The problem for many value investors is that companies with sustainable competitive advantages often trade at premiums to the market. Nevertheless, if you look hard enough, there are some good deals out there.
Here are some reasonably priced stocks with superior (and growing) returns on invested capital:
Autozone Inc (NYSE: AZO)
12-month ROIC: 44.0%
5-year average ROIC: 33.6%
Forward P/E: 13.9
Varian Medical (NYSE: VAR)
12-month ROIC: 29.7%
5-year average ROIC: 28.6%
Forward P/E: 16.8
Dollar Tree Inc (Nasdaq: DLTR)
12-month ROIC: 32.5%
5-year average ROIC: 22.5%
Forward P/E: 16.6
Zacks.com is a property of Zacks Investment Research, Inc., which was formed in 1978 by Len Zacks. The company continually processes stock reports issued by 3,000 analysts from 150 brokerage firms. It monitors more than 200,000 earnings estimates, looking for changes.
Then when changes are discovered, they're applied to help assign more than 4,400 stocks into five Zacks Rank categories: #1 Strong Buy, #2 Buy, #3 Hold, #4 Sell, and #5 Strong Sell. This proprietary stock picking system; the Zacks Rank, continues to outperform the market by nearly a 3 to 1 margin. The best way to unlock the profitable stock recommendations and market insights of Zacks Investment Research is through our free daily email newsletter Profit from the Pros. In short, it's your steady flow of profitable ideas GUARANTEED to be worth your time. Get your free subscription to Profit from the Pros at: http://at.zacks.com/?id=7298
Follow us on Twitter: http://twitter.com/ZacksResearch
Join us on Facebook: http://www.facebook.com/ZacksInvestmentResearch
Zacks Investment Research is under common control with affiliated entities (including a broker-dealer and an investment adviser), which may engage in transactions involving the foregoing securities for the clients of such affiliates.
Disclaimer: Past performance does not guarantee future results. Investors should always research companies and securities before making any investments. Nothing herein should be construed as an offer or solicitation to buy or sell any security.
Zacks Investment Research
800-767-3771 ext. 9339
SOURCE Zacks Investment Research, Inc.
More by this Source
The Zacks Analyst Blog Highlights: RadioShack, Amazon.com, Best Buy, Conns and Alkermes
Mar 10, 2014, 09:30 ET
Browse our custom packages or build your own to meet your unique communications needs.
Learn about PR Newswire services
Request more information about PR Newswire products and services or call us at (888) 776-0942.