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Who Cares About Returns on Capital These Days?

GuruFocus.com

- By Steven Chen


"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share."

- Warren Buffett (Trades, Portfolio)




Warren Buffett (Trades, Portfolio) has this simple test above to measure the performance of a management team. I would bet that most business-perspective investors would stand by the Oracle of Omaha and even employ the metric to filter out well-managed businesses that are hopeful of outperforming. So shouldn't the executive world agree?

Over the years, we digest information through investor materials (i.e., filings, reports, presentations, webcasts) provided by publicly-traded companies around the world. It has actually been a bit surprising to us at Urbem that very few managements ever explicitly emphasize this figure in any sort of way. We find that this phenomenon applies to companies globally and even to those who have achieved a superior return on capital. The prevalent metrics, as you may have imagined, include top-line/bottom-line growths and margins, which, more or less, implies some short-termism and a Wall-Street-oriented mindset, in our view.

Throughout our investing journey, we did encounter some "silver linings" from time to time in this regard. The management teams of the below companies like to track, talk about and concentrate on the return on capital over time, with some even "daring" to set a target on it. One commonality among these stocks is that they all deliver super-normal total shareholder returns over time.

Please beware that the majority of the names here come from our investable universe (consisting of companies that we follow closely), and hence, the list is far from being complete. If you find any more of the rare species of return-on-capital-focused companies, feel free to comment below, as we would be quite interested in them.

Graco (NYSE:GGG)

Minnesota-based Graco is the leading manufacturer of fluid-handling systems and products. Aiming to drive double-digit growth in sales and earnings, the company is committed to capital spending when it comes to research and development or bolt-on acquisitions.

To measure the efficiency of such endeavors, any metric relating to growth alone would not suffice. Instead, the management appears to emphasize the return on capital by having tracked the long-term average return on invested capital, equity and assets in every investor presentation over the past few years.

Halma (LSE:HLMA)

UK-based Halma is a leading provider of life-saving technologies. We as investors like the company for its intended balance between both growth and returns. As the company's investor relations website explicitly puts it, "we aspire to double our earnings per share every five years, while maintaining high returns (Return on Sale, Return on Capital Expenditure)."

Ccompared to Graco, Halma employs a more acquisition-driven approach with ten companies acquired over the previous fiscal year for 238 million British pounds ($304 million) in total, or 18% of annual sales, which may concern many investors at first glance. Fortunately, the management is disciplined and only considers opportunities in high return, global niches with long-term growth drivers.

Kakaku.com Inc. (TSE:2371)

Kakaku.com Inc. is Japan's leading Internet conglomerate operating a range of platforms, include its namesake price comparison website as well as Tabelog, a restaurant discovery and reservation site.

As with Halma, Kakaku.com aims to deliver shareholder value by achieving a balance between growth and returns, which in the management's own words would be "(to) realize stable profit growth through business expansion and optimal resource allocation." The management ambitiously targets a 40% return on equity, while keeping investing in existing and new platforms as well as acquisitions and minority equity interests. The financial data shows that the company has achieved this goal every year since fiscal 2014.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Kakaku.com.

Read more here:

  • 2 Cases to Demonstrate the Natural Hedge

  • Urbem's 'Megatrend' Series: Sheconomy

  • Urbem's 'Quality Strategy' Series: Operational Gearing



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This article first appeared on GuruFocus.