Dow Jones MarketWatch, September 1, 2022, article: "You need quality stocks during times of turmoil. Here’s one good strategy for picking them" [Renewed attention to a company's ability to generate sustainable profits from use of investors' capital]

Source: Dow Jones MarketWatch, September 1, 2022 (updated Sept. 3), article

Deep Dive

You need quality stocks during times of turmoil. Here’s one good strategy for picking them

Last Updated: Sept. 3, 2022 at 10:23 a.m. ET
First Published: Sept. 1, 2022 at 2:23 p.m. ET

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There is a close correlation between returns on invested capital and stock performance over long periods. Apple ranks high by both measures.

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You may be aware of how difficult it is for fund mangers to outperform stock indexes. And now all investors face the challenge of a slowing economy as the Federal Reserve tightens monetary policy to cool the U.S. economy and clamp down on inflation.

Selecting individual companies for investment is difficult — you need to look back at performance but also look ahead, not only at estimates but to consider subjective factors. How likely is it that a company you are interested in will remain a top provider of goods and services in its industry? Could that industry, itself, be threatened over the long term?

What follows is a review of the S&P 500 SPX to focus on one metric that is closely tied to outperformance, followed by more information about a select group of companies that might help you with your own subjective analysis.

ROIC and 10-year outperformance

A company’s return on invested capital (ROIC) is defined by FactSet as earnings divided by the sum of the carrying value of a company’s common stock, preferred stock, long-term debt and capitalized lease obligations. It is an annualized figure.

ROIC sheds light on a corporate management team’s ability to make the most efficient use of the money invested to fund its business.

The carrying value of a company’s stock may be much lower than its current market capitalization. The company may have issued most of its shares many years ago at a price much lower than today’s. If a company has issued a relatively large amount of newer shares recently, or at high prices, its ROIC will be lower.

A company with a high ROIC is likely to have a relatively low amount of long-term debt on its balance sheet, or at least to have made efficient use of the borrowed money.

Some businesses are more capital intensive than others, which means ROIC comparisons might be most meaningful within specific industries. But that is not what we are doing in this screen of stocks.

For a top-down approach, there is no need to make fair comparisons. Looking back 10 years (actually the most recent 40 quarters of data available from FactSet), ROIC data is available for 453 members of the S&P 500.

Here are the 20 companies in the S&P 500 that have achieved the highest average ROIC over the past 10 years:

Company	Ticker	Industry	Average ROIC — past 40 quarters	Total return — 10 years
VeriSign Inc.	VRSN	Internet Software/ Services	270.1%	282%
HP Inc.	HPQ	Computer Processing Hardware	69.2%	398%
Domino’s Pizza Inc.	DPZ	Restaurants	64.4%	1,058%
Philip Morris International Inc.	PM	Tobacco	51.4%	75%
Accenture PLC Class A	ACN	Information Technology Services	46.3%	466%
Mastercard Inc. Class A	MA	Misc. Commercial Services	44.8%	713%
Idexx Laboratories Inc.	IDXX	Medical Specialties	42.9%	631%
AutoZone Inc.	AZO	Specialty Stores	41.3%	486%
S&P Global Inc.	SPGI	Financial Publishing/ Services	38.0%	711%
Paychex Inc.	PAYX	Data Processing Services	37.1%	410%
Cboe Global Markets Inc.	CBOE	Investment Banks/ Brokers	36.6%	394%
Yum Brands Inc.	YUM	Restaurants	35.6%	194%
Marriott International Inc. Class A	MAR	Hotels/ Resorts/ Cruiselines	34.1%	354%
Intuit Inc.	INTU	Software	33.5%	709%
Colgate-Palmolive Co.	CL	Household/ Personal Care	32.9%	85%
Ross Stores Inc.	ROST	Apparel/ Footwear Retail	32.8%	174%
Apple Inc.	AAPL	Telecommunications Equipment	32.6%	672%
Robert Half International Inc.	RHI	Personnel Services	32.0%	253%
Lockheed Martin Corp.	LMT	Aerospace & Defense	32.0%	520%
FactSet Research Systems Inc.	FDS	Data Processing Services	31.4%	425%
Source: FactSet

Click on the tickers for more about each company. Then, as part of your own analysis, read Tomi Kilgore’s detailed guide to the wealth of information available for free on MarketWatch quote pages.

Note that FactSet Research Systems Inc. FDS, which provided the data for this article, ranks 20th on the list.

The table includes 10-year total returns for the stocks, with dividends reinvested. Of the 20 companies, all but four have beaten the S&P 500’s 10-year return of 242% through Aug. 31.

Looking ahead: expected increases in sales and earnings

The lookback at ROIC for such a long period sheds light on how important it can be to remain committed for years. If we look ahead, estimates generally go out only two or three years. For this group, let’s look at estimated compound annual growth rates (CAGR) for the net two calendar years for revenue and for earnings per share. Many companies have fiscal years that don’t match the calendar, but FactSet provides calendar-year estimates.

Leaving the group in the same order, here are expected CAGR for sales and growth through 2024:

Company	Ticker	Two-year estimated sales CAGR through 2024	Two-year estimated EPS CAGR through 2024
VeriSign Inc.	VRSN	N/A	N/A
HP Inc.	HPQ	1.5%	4.6%
Domino’s Pizza Inc.	DPZ	6.8%	16.7%
Philip Morris International Inc.	PM	5.6%	7.9%
Accenture PLC Class A	ACN	9.3%	12.6%
Mastercard Inc. Class A	MA	16.0%	20.8%
Idexx Laboratories Inc.	IDXX	9.2%	18.7%
AutoZone Inc.	AZO	4.5%	9.9%
S&P Global Inc.	SPGI	8.0%	18.8%
Paychex Inc.	PAYX	6.7%	8.0%
Cboe Global Markets Inc.	CBOE	4.9%	5.1%
Yum Brands Inc.	YUM	7.4%	14.7%
Marriott International Inc. Class A	MAR	8.2%	16.9%
Intuit Inc.	INTU	14.2%	17.1%
Colgate-Palmolive Co.	CL	3.2%	8.3%
Ross Stores Inc.	ROST	6.1%	14.3%
Apple Inc.	AAPL	5.0%	7.2%
Robert Half International Inc.	RHI	3.2%	3.9%
Lockheed Martin Corp.	LMT	2.6%	15.5%
FactSet Research Systems Inc.	FDS	8.0%	10.4%
Source: FactSet

In comparison, weighted estimates call for a two-year sales CAGR of 4.5% and two-year EPS CAGR of 8.4% for the S&P 500.

For VeriSign Inc. VRSN, no estimates are available for calendar 2024. Analysts polled by FactSet expect the company’s sales in 2023 to increase by 6.4% to $1.42 billion and its earnings per share to increase by 10.9% to $6.74.

Keep in mind that a slow growth rate combined with continued high ROIC might still make for a good investment, provided a company remains a leader in its industry. This might apply to Apple Inc. AAPL.

Looking ahead: ratings and price targets

Sell-side analysts (that is, those who work for brokerage firms) tend to avoid placing negative ratings on stocks. One reason is that bad news or a long decline for a company may already be “baked into” its share price.

But it can still be worthwhile to look at consensus ratings and price targets. They are based on 12-month outlooks for companies’ financial results and for stock-price movements. Here’s a summary for the group:

Company	Ticker	Share “buy” ratings	Share neutral ratings	Share “sell” ratings	Closing price — Aug. 31	Consensus price target	Implied 12-month upside potential
VeriSign Inc.	VRSN	33%	67%	0%	$182.22	$205.00	13%
HP Inc.	HPQ	11%	67%	22%	$28.71	$31.60	10%
Domino’s Pizza Inc.	DPZ	29%	68%	3%	$371.86	$428.63	15%
Philip Morris International Inc.	PM	56%	44%	0%	$95.49	$109.57	15%
Accenture PLC Class A	ACN	65%	35%	0%	$288.46	$350.71	22%
Mastercard Inc. Class A	MA	92%	8%	0%	$324.37	$425.48	31%
Idexx Laboratories Inc.	IDXX	58%	34%	8%	$347.62	$495.88	43%
AutoZone Inc.	AZO	67%	25%	8%	$2,119.21	$2,233.79	5%
S&P Global Inc.	SPGI	90%	10%	0%	$352.18	$406.50	15%
Paychex Inc.	PAYX	15%	80%	5%	$123.34	$127.78	4%
Cboe Global Markets Inc.	CBOE	50%	36%	14%	$117.97	$136.27	16%
Yum Brands Inc.	YUM	38%	62%	0%	$111.24	$134.50	21%
Marriott International Inc. Class A	MAR	47%	53%	0%	$153.74	$170.56	11%
Intuit Inc.	INTU	87%	13%	0%	$431.78	$550.28	27%
Colgate-Palmolive Co.	CL	30%	70%	0%	$78.21	$82.67	6%
Ross Stores Inc.	ROST	54%	46%	0%	$86.27	$95.57	11%
Apple Inc.	AAPL	78%	17%	5%	$157.22	$182.87	16%
Robert Half International Inc.	RHI	29%	28%	43%	$76.97	$80.50	5%
Lockheed Martin Corp.	LMT	25%	75%	0%	$420.11	$460.39	10%
FactSet Research Systems Inc.	FDS	22%	56%	22%	$433.34	$435.91	1%
Source: FactSet

Mastercard Inc. MA is the analysts’ favorite, with 92% “buy” or equivalent ratings, followed by S&P Global Inc. SPGI at 90%, Intuit Inc. INTU at 80% and Apple at 78%.

The company with the highest number of “sell” or equivalent ratings is Robert Half International Inc. RHI, possibly reflecting a difficult environment for a staffing company at a time of such low unemployment.

In the end, you will need to do some deep thinking to form your own opinion about how well a company may continue to compete, or even if it might face an existential threat to its business over the years.

About the Author

Philip van Doorn

Philip van Doorn writes the Deep Dive investing column for MarketWatch.