MW 20 value stocks scoring highest for long term returns on invested capital
By Philip van Doorn
Investors have been looking at a "Great Rotation" to value-oriented stocks and away from Big Tech. That means it is time to screen value stocks for long-term quality.
Wednesday's action in the stock market was brutal for some popular tech-oriented names that had been performing well. There has been a three-week trend toward value-oriented stocks and away from Big Tech, and if you believe this trend is going to last, you might want to take a look at value stocks screened for quality.
The Magnificent Seven group of stocks (Microsoft Corp. $(MSFT)$, Apple Inc. $(AAPL)$, Nvidia Corp. $(NVDA)$, Amazon.com Inc. $(AMZN)$, Meta Platforms Inc. (META), Alphabet Inc. $(GOOGL)$ and Tesla Inc. $(TSLA)$), which make up 31% of the SPDR S&P 500 ETF Trust SPY, saw their combined market capitalization fall by $1.7 billion for two weeks through Wednesday.
A value stock is generally considered to be one which is trading relatively low to its expected earnings per share or to book value, and/or of a company expected to expand relatively slowly.
Joseph Adniolfi looked into what is being called the "Great Rotation" into value and small-cap stocks after many years during which stocks of rapidly growing companies, especially in the information technology sector, had dominated the market action. He described three factors that might determine how long this trend will last.
To set the stage for a value-stock screen let's begin with a look at how several broad stock indexes have performed through Wednesday:
Index Total return for three weeks through July 24 2024 return 2023 return 2022 return Return since end of 2021
S&P 500 -1.9% 14.7% 26.3% -18.1% 18.6%
Dow Jones Industrial Average 1.5% 6.9% 16.2% -6.9% 15.6%
Nasdaq Composite Index -4.6% 16.0% 44.6% -32.5% 13.2%
Nasdaq-100 Index -5.7% 13.6% 55.1% -32.4% 19.2%
Russell 1000 -1.7% 13.8% 26.5% -19.1% 16.4%
Russell 1000 Growth -5.4% 17.1% 42.7% -29.1% 18.4%
Russell 1000 Value 2.8% 9.3% 11.5% -7.5% 12.7%
Source: FactSet
Returns are shown going back to the end of 2021, to show the pattern of decline and recovery, especially for growth-oriented stocks, in 2022 and 2023.
The action for the indexes underscore the kindling of investors' interest in value stocks.
Screening the Russell 1000 for long-term quality
The Russell 1000 Index RUI is made up of the 1,000 largest companies in the Russell 3000 Index RUA, which itself is meant to encompass 98% of the U.S. market for publicly traded common stocks.
The Russell 1000 Value Index RLV is a subset that includes 872 companies with relatively low price-to-book ratios, lower growth estimates for the next two years and lower sales-growth figures over the past five years. You can read more about FTSE Russell's selection and weighting methodology for the index here.
There are various ways to screen stocks. Sometimes we look ahead using consensus estimates among analysts working for brokerage firms. This time, we are looking at returns on invested capital.
A company's return on invested capital $(ROIC)$ is its profit divided by the sum of the carrying value of its common stock, preferred stock, long-term debt and capitalized lease obligations.
ROIC is an annualized figure that sheds light into how efficiently a corporate management team allocates investors' money. It isn't a perfect tool to measure performance, in part because some industries are more capital-intensive than others.
Keep in mind that the carrying value of a company's stock may be much lower than its current market value. The company may have issued most of its shares many years ago at a price much lower than today's price. If a company has issued a relatively large amount of shares recently, or at high prices, its ROIC will be lower. If a company has low debt, its ROIC is higher. If a company is being forced to increase borrowings, its ROIC will go down.
To screen the Russell 1000 Value Index, we looked at the companies' average ROIC over the past 10 years, as calculated by FactSet. Each quarter FactSet calculates ROIC for the past four quarters. To calculate 10-year average ROIC, we looked at the data for the most recent quarter, then four quarters previous and so on. If FactSet lacked all the data needed to calculate ROIC for a company's most recent reported quarter (since the full set of data may not be reported until several weeks after the initial press release) we looked at the previous quarter, and then four quarters earlier from there. So the data for the 10-year averages goes back 40 or 41 quarters.
Then after seeing which companies had the highest 10-year average ROIC, we cut the list to include only companies whose three-year average ROIC were higher than their 10-year averages.
So here are the 20 components of the Russell 1000 Index with the highest 10-year ROIC that have also shown recent improvement based on their three-year ROIC:
Company Ticker 10-year average ROIC 3-year average ROIC 2024 total return 10-year total return VeriSign Inc. VRSN 231.9% 284.8% -15% 251% Ubiquiti Inc. UI 57.8% 63.9% 20% 335% Yum Brands Inc. YUM 40.5% 42.5% -3% 186% AutoZone Inc. AZO 39.5% 42.7% 14% 471% Lennox International Inc. LII 37.3% 42.9% 21% 579% Automatic Data Processing Inc. ADP 34.0% 43.7% 7% 326% O'Reilly Automotive Inc. ORLY 33.3% 42.0% 11% 592% Robert Half Inc. RHI 32.4% 33.4% -25% 55% Texas Instruments Inc. TXN 31.7% 32.0% 18% 442% Landstar System Inc. LSTR 30.4% 36.2% -4% 213% Williams-Sonoma Inc. WSM 28.6% 41.6% 52% 459% NVR Inc. NVR 28.1% 34.1% 20% 643% Expeditors International of Washington Inc. EXPD 27.1% 31.2% -2% 209% Fastenal Co. FAST 26.8% 30.0% 5% 290% Lam Research Corp. LRCX 26.0% 36.9% 17% 1402% Applied Materials Inc. AMAT 25.1% 35.6% 28% 983% Chemed Corp. CHE 24.9% 26.1% -6% 466% Old Dominion Freight Line Inc. ODFL 24.5% 33.5% -4% 845% NetApp Inc. NTAP 23.5% 30.0% 45% 325% Illinois Tool Works Inc. ITW 23.0% 30.6% -8% 253% Source: FactSet
VeriSign $(VRSN)$ typically ranks highest on this type of list. The company has a dominant market position in internet domain registry services - a business that is not capital-intensive.
These companies have tended to perform well, based on 10-year total returns with dividends reinvested (the right-most column on the table).
16 out of 20 have beaten the S&P 500's 230% 10-year return.10 have beaten the Russell 1000 Growth Index's 10-year return of 338%.19 have beaten the Russell 1000 Value Index's 10-year return of 124%.
Keep in mind that a stock screen guarantees nothing. It can be a useful starting point for your own research as you form your own opinion about how well a company is likely to remain competitive over the next decade at least.
One way to begin your own research is to click on the tickers for more information.
Read: Tomi Kilgore's guide to the wealth of information available for free on the MarketWatch quote page.
Other stock screens for investors interested in the "Great Rotation:"
This S&P 500 sector is expected to grow profits most rapidly through 2026 - and it's not tech. Here are 14 related stocks.20 value stocks with high dividend yields and expected room to raise payouts
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July 25, 2024 11:01 ET (15:01 GMT)
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