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Stalwart Stocks With High Returns on Capital

GuruFocus.com
·6 min read

- By Robert Abbott

If you ask Google to define "stalwart," it will return this: "loyal, reliable, and hardworking." The legendary investor Peter Lynch no doubt had these characteristics in mind when he was describing one type of stock.

Actually, he had a hierarchy of stocks that he followed: slow growers, stalwarts, fast growers, cyclicals, turnarounds and asset opportunities.


Stalwarts were solid, mature stocks that could continue to grow their earnings by 10% to 12% per year. Not only do these stocks provide stabilization during volatile markets, but they can also provide decent capital gains if purchased at a low price. I often think of Warren Buffett (Trades, Portfolio)'s portfolio in Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) when I think of stalwarts; it includes companies such as Coca-Cola (NYSE:KO), Wells Fargo (NYSE:WFC) and Apple (NASDAQ:AAPL).

To find stalwarts, GuruFocus Premium subscribers can use a screener called "The Stalwarts." Companies that make it through this screener have met several criteria:

  • Predictability: At least 2 stars out of 5 (a low bar).

  • ROC or ROIC: A 10-year median of at least 14%.

  • Revenue growth: Averaging 8% to 22% over the previous 10 years.

  • Earnings per share without non-recurring items: 10% to 20% over the past 10 years.



On Nov. 12, 65 stocks had made it through the screener. When sorted by return on capital, the top three were:

  • NIC Inc. (NASDAQ:EGOV)

  • Nathan's Famous Inc. (NASDAQ:NATH)

  • Cboe Global Markets Inc. (CBOE)



NIC

Based in Olathe, Kansas, NIC may have been the intermediary that led you to online state services such as licenses, permits and access to government documents.

It has a business model that many state governments find attractive. According to its 10-K for 2019, NIC designs, builds and operates digital government services on an enterprise-wide basis. The company funds and takes all risks upfront. In return, it collects a fee for each transaction it processes, and it processes literally billions of transactions a year.

Because of the nature of NIC's up-front costs and risks, it normally negotiates multiyear contracts with its government partners. This, along with integration into government systems, gives the company a moat or competitive advantage.

To grow its revenue, it can sign contracts with new customers, deliver new services to existing partners and sign long-term contracts with its government partners.

In its software and services businesses, it provides payment processing services, software development and digital government services to federal agencies, as well as state and local governments.

NIC has a strong set of fundamentals:

  • Financial strength: 7 out of 10 (little debt).

  • Profitability: 8 out of 10.

  • Return on capital: 141.5% (return on equity is 23.6%).

  • Dividend: 1.49%, with no recent increases.

  • Three-year share-buyback ratio: -0.50 (it has been issuing more shares than it repurchased).



Since we're dealing with a Peter Lynch investment concept, we'll also use a Lynch chart to assess NIC's value. He believed that when the share price fell well below the earnings line, it was a buying opportunity, and selling opportunities occurred when the price line was above the earnings line. Or, more simply, buy when the blue line (share price) is below the green line (earnings line):

Stalwart Stocks With High Returns on Capital
Stalwart Stocks With High Returns on Capital

While dealing with the relationship between prices and earnings, as displayed in the chart, Lynch also came up with the PEG ratio (shown in the Valuation section of the Summary pages). It is calculated by dividing the price-earnings ratio by the Ebitda growth rate (over the past five years).

NIC has a PEG ratio of 1.78 (where 1.00 represents fair valuation), confirming the overvaluation we see in the chart.

Nathan's Famous

When it comes to word pairing, most Americans would quickly associate the name Nathan's with hot dogs. This Jericho, New York-based company began as a hot dog stand on Coney Island in 1916.

As the company puts it in its 10-K for the year ending March 29, 2020, it has "evolved into a highly recognized brand throughout the United States and the world. Our innovative business model seeks to maximize the points of distribution for and the consumption of Nathan's World Famous Beef Hot Dogs, crinkle-cut French fries and our other products across a wide-range of grocery retail and foodservice formats."

That formula has been a success. Nathan's now sells its products through 78,000 locations in the U.S. (including 64,000 supermarket and mass merchandiser retailers) and in 11 other countries and territories. In addition, it sells through franchisees.

The company stated it is part of the foodservice industry; one of its current growth initiatives is in co-branding deals "within other foodservice environments." In addition to its hot dog operations, Nathan's also owns the Arthur Treacher's brand and trademarks, giving it a seafood menu-line extension.

From an investing perspective, here's how the financials shape up:

  • Financial strength: 4 out of 10 (a significant amount of debt added since 2015).

  • Profitability: 8 out of 10 (its operating margin and net margin are in double-digits).

  • Return on capital: 124.11% at the end of September.

  • Dividend yield: 2.36%

  • Share buyback ratio: 0.3 over the past three years.



According to the Peter Lynch chart, Nathan's is slightly overvalued:

Stalwart Stocks With High Returns on Capital
Stalwart Stocks With High Returns on Capital

Nathan's PEG ratio is 2.14, also indicating overvaluation.

Cboe Global Markets

Best known as the home of stock options, the Cboe now operates in five business segments: options, U.S. equities, futures, European equities and global foreign exchange.

It noted in its 10-K for 2019: "In addition to our exchanges providing a marketplace and listing venue for the trading of securities and derivatives we also calculate proprietary indices that are used as the basis for proprietary products or licensed for use by third parties." This includes the VIX, the so-called fear index or fear gauge that tracks market volatility.

Cboe has a strong set of fundamentals that help qualify it as a stalwart:

  • Financial strength: 7 out of 10.

  • Profitability: 9 out of 10.

  • Return on capital: 7.63% at the end of the third quarter (ROE is 14.01%).

  • Dividend yield: 1.78% and the dividend growth rate over the past three years averaged 11.8%.

  • Share buyback ratio: -10.8 over the past three years.



Like the other two stocks we've assessed, Cboe is overvalued:

Stalwart Stocks With High Returns on Capital
Stalwart Stocks With High Returns on Capital

This overvaluation is backed up by the PEG ratio at 2.14.

Conclusion

The idea of stalwart stocks is a useful one to add to our investment toolkits. The name signifies mature, no-surprise stocks that continue to grow their earnings and share prices. Some also offer reasonable dividends and share buybacks to enhance shareholder returns.

NIC, Nathan's Famous and Cboe all fit the bill for investors who want growth with minimal risk. As we've seen, though, investors who wanted to buy them had to pay a premium (with one brief exception).

Given the high valuations, few value investors will find much of interest here, barring market-wide meltdowns. There is potential for growth investors here, but is that growth aggressive enough to suit them? And income investors will look elsewhere for even more mature stocks that pay higher dividends.

Disclosure: I do not own shares in any of the companies named in this article.

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This article first appeared on GuruFocus.