Constant Growers For Your Portfolio

Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

While recently browsing in the business section of a used bookstore, I found a misplaced copy of “The Constant Gardener” by master spy novelist John le Carre.  I know very little about the plot of the novel but the title suggested an intriguing investment angle as it sat there, out of place, amongst the finance books.  An image of an old, rich man tending to his garden of growing stocks came into my head and I wondered if I could create a screen for “constant grower” stocks. I then wondered if I could identify, beyond the screening criteria, any common characteristics of the companies that popped up.

I ran a screen that first required companies increase revenue in each of the past 10 years and for the trailing twelve months over the last full fiscal year.  Next, I wanted only those companies that reported positive earnings, operating cash flow, and free cash flow in each of the past ten years and for the trailing twelve months.  My third criteria required companies increase operating cash flow and free cash flow in each of the past three years and for the trailing twelve months over the last full fiscal year.  Finally I required the companies to have a minimum $5 billion market capitalization to “weed out” thinly traded illiquid stocks.  This rigorous screen produced only 4 companies, Apple (NASDAQ: AAPL), Citrix Systems (NASDAQ: CTXS), Edwards Lifesciences (NYSE: EW), and Express Scripts (NASDAQ: ESRX).

One thing I noticed about this screen was the diversity of industries represented.  Apple is a familiar name in consumer technology while Citrix develops software tools, Edwards makes medical devices and Express Scripts manages pharmacy benefits.  The variety of the companies in this group shows that quality companies can come from any industry and confirms my preference for a bottoms up approach over sector or industry selection.

10 year total return relative to the S&P 500
Each of these companies produced compound annual total returns that were at least 11% above the annual total return for the S&P 500 over the past 10 years.  Apple led the pack with total returns just under 54% annually which is about 47 percentage points above the 7% annual return for the S&P 500.  Express Scripts, Edwards, and Citrix produced compound annual total returns of almost 18, 15, and 11 percentage points, respectively, above the S&P 500 over the past 10 years.

Operating Cash Flow and Free Cash Flow as a % of Revenue
In addition to market beating returns, three of these companies also generate high cash flow per dollar of revenue.  Over the past 10 years, Citrix, Apple, and Edwards have averaged operating cash flow of approximately 33%, 21%, and 17% of revenue, respectively, while Express Scripts has averaged less than 5%. Similarly, Citrix, Apple and Edwards have generated free cash flow of almost 28%, 18%, and 12% of revenue, respectively.  Express Scripts is again the laggard with average free cash flow to revenue of just more than 4% over the past 10 years.

Another way to look at the relationship between cash flow and revenue is to compare the ratio of revenue growth over the past 10 years to operating cash flow growth and free cash flow growth over the same period.  For Apple the ratios of revenue growth to operating cash flow growth and free cash flow growth are 0.6x and 0.5x, respectively, both of which are the lowest of these companies.  Citrix has the highest ratios at 1.1x and 1.2x operating cash flow growth and free cash flow growth, respectively, while Edwards carries ratios of 0.9x and 0.8x, respectively, and Express Scripts 0.8x and 0.75x, respectively.  From these figures we see that while Citrix on average has generated more cash flow per dollar of revenue, Apple’s cash flow generating capacity has required less revenue growth which is one reason it has produced such high returns over the past 10 years.

Return On Invested Capital (ROIC)
Another reason for Apple’s high shareholder returns over the past 10 years and an indicator of its operational excellence is its incredible ROIC.  The company has averaged nearly 29% over that time compared to 18% for Express Scripts, about 12% for Citrix, and more than 11% for Edwards.  Even more impressive is that Apple has actually improved its ROIC to the high 30% to low 40% range in the past several years from the low 20% range a decade ago even as it has increased its asset base from less than $10 billion to more than $170 billion.

Price to earnings to growth (PEG) multiples
I was surprised to find that these companies are still relatively inexpensive.  Despite their high total returns and continued strong operating performance, these companies’ shares have not been over bought by investors.  Apple currently has a PEG multiple of just 0.66x with analysts projecting future EPS growth of about 14% which is a significant decrease from the 70% plus growth in the last 3 and 5 year periods.  Edwards has the highest PEG of the group but it is a very reasonable 1.0x with EPS forecast to grow by about 28%, in line with the growth achieved over the past 3 years but higher than the 5 and 10 year averages.

Citrix and Express Scripts are similarly valued at PEGs of about 0.8x but Citrix is expected to grow EPS by about 28% compared to 18% for Express Scripts.  The expected growth of Citrix is an a par with its growth the past 3 years which is elevated from about 15% over the past 5 and 10 year periods.  Express Scripts has been able to consistently grow EPS by about 25% over the past 3, 5 and 10 year periods so its future growth rate of 18% represents a lowering of expectations.  It is not possible to know how close actual EPS growth will be to analysts’ estimates but in each case the estimates are either consistent with or decreased from recent growth rates which suggests these outstanding companies are well positioned to meet expectations and justify their current valuations.

These companies have several common attributes which have helped them achieve compound annual total returns over the past decade well in excess of the S&P 500.  First, with the exception of Express Scripts, they generate substantial cash flow per dollar of revenue.  They also do not require high revenue growth to obtain cash flow growth.  Secondly, they generate solid or even very high ROIC.  Lastly, each of these companies utilizes little financial leverage with only Express Scripts having any long term debt at a manageable 28% of capital.  With these companies’ shares so attractively valued on a PEG basis and with reasonable growth expectations, investors now have a chance to roll up their sleeves, dig thoroughly into research, and cultivate their own garden of “constant growers” that should yield market beating returns over the long term.


56Steve has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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