A Magic Number for Long Term Returns
A powerful number when it comes to long-term returns in the stock market.
I mentioned in another post that investing $100.000 in Apple ($APPL) in the nineties would have returned over 40 million USD today.
What is needed to deliver such incredible results? In essence, it’s simple. We want to see a company that has a return on invested capital (ROIC) that is high and stays high over the years. Enough? Not yet.
We also want to see a company that grows, that keeps investing in the business while at the same time manages to keep a high ROIC.
Then we’ll see a growing and profitable business that will grow its valuation, inevitably.
ROIC and Assets Growth, year over year. This is what we want to see.
Companies with high ROIC and positive levels of Assets Growth for many years are not easy to find. Why? Because high ROIC brings competition. Competition brings declining ROIC. Unless the company manages to protect its ROIC from the competition.
The historic average ROIC for the whole SP500 is around 6% which is about the average cost of capital and around the average real return of the SP500 index since inception! The whole market tends towards this magic 6% number: ROIC, Returns, Cost of Capital.
6% is the magic number.
Great businesses create real value only when they manage to exceed the average cost of capital at 6%. Below that, a company is destroying value.
So how much value a company is creating at any given time? Simple: ROIC-6% = Value created.
A lot of my way of looking at investments revolve around this idea: finding businesses with a growing ROIC, companies that are investing (growing Assets), and are developing what Warren Buffett defines as a “MOAT”. A way to protect from the competition. A way to protect their ROIC, their profitability.
A monopoly has a MOAT as nobody can threaten a monopoly. In Italy, we have a company called Atlantia which is practically a monopoly as it manages the Italian highway system under a license from the government. Sure enough, Atlantia has delivered an average ROIC of around 100% for the last 10 years! Problem: they cannot expand such a business outside the country. So there is a limit to their upside potential. ROIC alone is not enough. We need growth, expansion which happen through investing back in the business.
Today's monopolies are created in the public markets by Brands (Apple, Coca-Cola, Tesla, Airbnb) or by technology or high switching costs (Microsoft).
That’s it: finding growing companies that deliver high ROIC and are becoming stronger at creating a MOAT is the mix I look for when picking a company to invest in. Growing sales is the ice on the cake.
Portfolio Update since inception on May 14 2021:
10X FREE Capital Pot: +21% (+18% vs. SP500)
10X Small Bets Pot (Subscribers only): 18.6% (+15.6% vs. SP500)
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Important:
this is not investment advice. Consult a licensed financial advisor before making any investment decision.