ROIC ROIC: Wall Street’s Road Kill James Boric discusses how to separate the squirrels of the small-cap market from the roadkill: look for companies with a high Return on Invested Capital, or ROIC. For 26 years, the symbol for Ralph Wanger’s small-cap Acorn Fund -- which averaged 17% from 1970 to 1996 -- was a squirrel. Not a bull. Not a lion. Rather, he used a small rodent that weighed about as much as my minuscule ThinkPad laptop to represent his mutual fund. Seems odd at first. But after thinking about it, a squirrel is a perfect metaphor for a small-cap company. Squirrels, like good small-cap companies, are nimble, efficient and adaptable. They are quick to avoid danger. They can thrive in small niches that most don’t even think to look in. And if they do get in trouble, they can outrun their larger predators or quickly change directions. Of course, not all squirrels survive. Some make the dubious mistake of running into a crowded street. A few unlucky rodents plunge to their death after stepping on an exposed power line. And the slower, fatter squirrels end up tasty morsels for their hungry prey. As Wanger said in his classic book, A Zebra in Lion Country, “you don’t see many three-hundred-pound squirrels in the park.” Squirrels that are slow and overweight can’t survive in the wild. And the same goes for over-leveraged and stodgy publicly traded companies. Unless a company is the lion or tiger in its industry -- meaning it is at the top of its game with barriers to entry that are too much for a smaller company to overcome -- it better be nimble enough to adapt, to innovate and to avoid danger. Otherwise it won’t make it. ROIC: Few Market Tigers Left And folks, last time I checked, there aren’t many tigers left in the wild. And the same is true in the market. Of the 5,877 companies that trade on the AMEX, NYSE and Nasdaq, there are only 784 large-cap beasts with a market cap of $5 billion or more. (Note: My guess is in the next year that number will decline as behemoths like GM, Ford and Kodak are added to the “extinct” list of publicly traded companies.) By comparison, there are 3,804 small-cap companies with a market capitalization of $1 billion or less. And while not every small-cap company will be around this time next year, the best returns will come from this list. They always do. ******************** The Hidden Drop in Home Prices Will Shock Owners They don't know about it yet,but they'll soon find out! While the sticker price goes up, up, up in most cities, home prices are going down in reality. It's only the beginning. Here's how you can protect yourself from the biggest one-year loss of wealth in world history... http://www.agora-inc.com/reports/DRI/EDRIFC05 ******************** So how can you separate the solidly run small-cap companies with bright futures from the companies that will end up as Wall Street road kill? One of the best ways is to look for businesses with a high return on invested capital (ROIC). Joel Greenblatt, the Gotham Capital founder who made 50% a year for an entire decade, succinctly described ROIC like this in his latest masterpiece, The Little Book That Beats the Market: “Buying a share of a good business is better than buying a share of a bad business. One way to do this is to purchase a business that can invest its own money at high rates of return rather than purchasing a business that can only invest at lower ones. In other words, businesses that earn a high return on capital are better than businesses that earn a low return on capital.” Translation: Companies that spend, manage and invest their money well are companies you want to own. Those are the companies that are growing. Those are the companies that are creating new, innovative products that command high profit margins. And those are the companies that add to shareholder wealth over time. So what is a healthy return on invested capital?
ROIC: Aim "Above Average" A recent study by Bin Jiang and Timothy Koller of McKinsey Global Institute found that from 1963-2004, the average ROIC for all publicly traded companies (excluding financial companies) with sales of at least $200 million was nearly 10%. In other words, over time, the average company on Wall Street will earn 10% for every dollar it invests in its business. But they are quick to point out that “companies that drive innovations in technology or business systems may earn above average returns…” Investing in those “above average” companies is exactly how guys like Ralph Wanger, Joel Greenblatt and Curtis Jensen (the fund manager for the Third Avenue Fund) have been able to average high returns year in and year out -- even when the market was weak. So where are those innovative companies located today? To find out, I ran a screen for every company on Wall Street with an above average ROIC of at least 30%. There were 165 companies (after excluding financial companies) that fit the bill. And after sorting through the data, here are some observations I made: - 87 of the companies with a high ROIC were small caps with a market cap of $1 billion or less - 51 were mid-caps with a market cap between $1-5 billion - And 27 were large caps with a market cap above $5 billion. Curiously enough, the textile (specifically, the footwear and clothing sectors), steel and iron, oil and refining and business and software services industries had the largest pool of companies with high ROICs -- those above 30%. Of the 165 companies on the list, seven were from the textile industry…seven were from the steel and oil industry…seven were from the oil and refining industry…and 17 came from the business services and software services industries. ******************** A Deal Made Over Several Gin and Tonics This company has $1 billion in cash, never takes a risk that isn't necessary and is growing its earnings by 49%. Buffett already has over $300 million in this company...it's one of the biggest in his portfolio. And it’s NOT a household name. “When it’s all said and done, this will be the only stock you need to own for the next 10 years,” said Chris Mayer, editor of Capital & Crisis. To prove it Chris is giving you a full five years to try us out and decide for yourself. If you are not 100% happy with the results you can cancel any time for a full refund. This deal was made over several gin and tonics. So get in before the hangover wears off. http://www.agora-inc.com/reports/FST/EFSTFC11 ******************** ROIC: The Ten Small-Caps with the Highest ROIC In weeks and months to follow, I’ll explore why those industries are so rich with well-run, innovative companies. And if you are a PSF reader, I’ll be recommending several companies from these industries in the months to come. But for now, I’ll leave you with a list of the top 10 small-cap companies with the highest ROIC: 1) Penn Octane Corp. (POCC:NASDAQ)…ROIC = 360 These small-cap companies are the squirrels of the market. They are wily, nimble and creative. As an investor, those are the kinds of businesses you want to put your money in. In fact, they are exactly the same kinds of companies a guy like Wanger might look for as candidates for his Acorn Fund. “A squirrel is…an interesting animal,” said Wanger in a 2000 interview. “It's not the strongest or smartest animal in the forest, but it is a very successful animal. There are squirrels in every country, because they are adaptable and opportunistic. For a small-stock manager, that's a good symbol. "Tigers are brave and beautiful, but they're nearly extinct. And bulls are strong and powerful, but they wind up as a beef patty between slices of bread. But squirrels are all over the place.” Invest in the squirrels. That’s my advice. Happy investing, ******************** “WORLD’S GREATEST HEDGE FUND” NOW ACCEPTING NEW INVESTORS Money Magazine said of this investment: “[it] has made millionaires out of hundreds of investors.” Kiplinger’s says of it: “a portfolio that has stood the test of time… better by a mile than any mutual fund.” Get complete details on how you can get into the "World's Greatest Hedge Fund" today -- read our FREE Investment Research report by clicking here. |
|
