ROIC On
Return on Invested Capital (ROIC) is a profitability ratio that measures the return that an investment generates for stockholders and investors. The higher the ROIC, the better the company is at turning capital into profits.
Warren Buffett famously wrote in its 2007 shareholder letter that "A truly great business must have an enduring 'moat' that protects excellent returns on invested capital."
Finding a company with a moat and great return on its invested capital however is tough, even for the Sage of Omaha, and ROIC purportedly is one of his favourite tool to find these gems.
His iconic business partner Charlie Munger added that “…we prefer business that can write us a check (give out dividends) at the end of the year.” at 2008 Berkshire Hathaway Annual Meeting.
Finally, Buffett's approach is to pay less than a company's intrinsic value, that is look for undervalued stocks to invest in . As he said, "…too-high purchase price for a stock of an excellent company can undo effects of subsequent decade of favourable business developments."
Uncovering Gems
Thus, I would attempt to shortlist a few businesses with high ROIC, that give dividends and see if they are currently undervalued as possible investment candidates.
While we could calculate ROIC manually, and might be good to complete at least one calculation to know where to obtain the necessary information, we can find many ROIC calculators online that get the job done. I’m going to rely on the later as I intend to compare ROIC, dividend and valuation metrics for a few big cap stocks in S&P500.
Running a screener from Sure Dividend available free to try online, we obtained a Table (below) with top-10 ranked by ROIC S&P 500 names (big cap, above 11.8bil). Zooming in on the top-3, we shortlisted $HP Inc(HPQ)$, $NortonLifeLock Inc.(NLOK)$ and $Starbucks(SBUX)$ with ROIC ranging from 192.3% to 141%, which also happen to offer dividend yield in the range of 2.9% to 1.8%. Of course, for both ROIC and dividend yield, the higher the better!
Top-10 ranked by ROIC stocks in S&P500. Source: Sure Dividend
To check if the stock price of the shortlisted 3 are undervalued or not, I use another free to try site Simply Wall St, which estimated the fair value using Discounted Cash Flow (DCF) methods. It showed (below) that NLOK current stock price is undervalued the most, 50.8% from fair value, with HPQ at 32.6% and SBUX at 25.8% undervalued from fair price.
Top-3 ranked by ROIC stocks, checking if they are undervalued. Source: Simply Wall St
HP is a Gem?
Considering all three metrics together, HPQ has the highest ROIC at 192.3%, best at turning capital into profits. While NLOK is the most undervalued, its dividend yield is much lower than HPQ’s 2.9%, and on balance, HPQ is the better bet.
Thus the gem that shines the brightest among the three high ROIC stocks is HP Inc. $HP Inc(HPQ)$. It’s probably no coincidence that recently, Buffett’s $Berkshire Hathaway(BRK.B)$ increased its stake in the IT company best known for PC, laptops and printers, to the tune of 121 millions shares worth $4.2billion!
Finding Gems from ROIC. Image source: AdventuresInCapitalism.com
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