Behind the Numbers: Three Extraordinary Stocks for Your Portfolio
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Some investors prefer paying a lot of attention to numbers and financial ratios in their search for the best investment alternatives, while others focus more on the story being those numbers and the qualitative aspects of different investment alternatives. But there is no reason to put one approach above the other; a strong financial performance is only the reflection of a successful business model. For this reason, quantitative screens can provide some very valuable ideas in our search for superior investment opportunities.
In the following table I have compiled financial statistics for the only three US listed stock which pass the following quantitative filters:
- A Return on Equity (ROE) above 35%, which finds companies which can compound their shareholder´s capital at extraordinary rates. ROE can be affected by the amount of financial leverage used by the company, particularly when a low return on assets is enhanced by leveraging those assets via debt.
- A Return on Assets (ROA) above 25%, which helps us avoid the most leveraged companies.
- An operating margin above 30% suggests the business can withstand fluctuations in revenue without losing too much profitability.
- A market cap above $15b avoids the more risky or complicated situations.
- Estimated growth rates of 12% or more annually over the next five years -- no boring elephants with slow growth ahead.
- P/E of 25 or less. Superior companies usually trade at above average valuations, but we'd still like an attractive price.
The screen is tremendously demanding, and that´s the main reason why only three companies have met all the requirements. But apart from valuation ratios, which are mostly determined by investors in the market and not direct responsibility of a company´s management, there are some interesting lessons to learn from analyzing this small group of high performing companies.
In order to pass this screen of the most distinguished stocks, a company needs to have a competitive advantage: something to differentiate itself from the competition and sustain higher profitability in a competitive environment. The competitive strength of these companies is the main reason why they show such an outstanding performance.
In many cases there is a combination of factors and not just one source of competitive advantages. Apple (NASDAQ: AAPL), for example, makes it into the screen thanks to several advantages like technological superiority, valuable patents and one of the most powerful brands in the world. Different sources of competitive advantages come sometimes reinforce each other, and that´s one of the reasons why the Cupertino giant has been such a profitable investment over the last years.
Priceline (NASDAQ: PCLN) is a more focused example, as brands and patents aren´t such an important factor in the online travel business. Customers can quickly switch to the site which offers them the most attractive deals, and that´s why Priceline needs to stay ahead of the competition in terms of better deals and more alternatives. Technology and innovation are determinant factors in online travel.
The biggest risk for Priceline is the possibility of having to fight a stronger competitor in the middle term, and Google (NASDAQ: GOOG) looks like the most threatening menace for the company. The online search giant has unparalleled reach all over the internet, and it has already taken some timid steps into the travel business. If Google decided to bet strongly on online travel, Priceline would need to face a gigantic competitor with much deeper pockets.
Just like technology is vital for companies in some industries, brand name can be a key asset in businesses like retail and fashion. One winning company in that sector is Coach (NYSE: COH). The marketer of high end bags and accessories has profitability numbers well above the competition due to a combination between higher prices for its products and strong operational efficiencies at the company level.
Coach has a powerful brand commanding higher price tags for clients and bigger profitability for shareholders, and that´s one of the most attractive competitive advantages you can have in the fashion industry. Also, the company has very interesting prospects for growth in Asia, where its products seem to resonate especially well among consumers and economic growth is stronger than in developed countries.
An extraordinary financial performance is simply the reflection of good things happening from a business point of view, and quantitative screens can be a powerful tool to identify the best companies for your portfolio. As long as these businesses are able to sustain their competitive strength over the long term, they should be able to translate their outstanding profitability into higher returns for shareholders over the years.
acardenal owns shares of Apple, Google and Coach. The Motley Fool owns shares of Apple, Coach, Google, and Priceline.com. Motley Fool newsletter services recommend Apple, Coach, Google, and Priceline.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.