An Investing Crystal Ball
By Shruti Basavaraj (TMF Bell)
As investors, we're all looking for a way to identify great investments. But we can't tell the future.
Nevertheless, there are indicators that can help us identify opportunities before the broader market. One of these is return on invested capital (ROIC).
Sparkling returns
If you've been around Fooldom for a while, you've definitely heard of ROIC. It's one of the tools hedge fund manager Joel Greenblatt outlines as part of his "magic formula" in The Little Book That Beats the Market. The number essentially measures the return that a company generates on every dollar of invested capital in its business -- and a high ROIC generally means a good business. An increasing ROIC, on the other hand, generally means an improving business. And that's our indicator of market opportunity.
Let's take a peek at some of the biggest growers of the past few year:
Company | ROIC | ROIC | ROIC | ROIC | ROIC | % Price | % Price |
|---|---|---|---|---|---|---|---|
NutriSystem | 40 | 23.7 | 25.5 | 8.7 | 3.1 | 663.6 | 4,220 |
Hansen Natural | 68.5 | 60.2 | 52.9 | 44.7 | 35.3 | 239.5 | 4,199.2 |
Ultra Petroleum | 44.5 | 39.3 | 35.8 | 34.7 | 31.1 | 151 | 3,944.4 |
USG | 54.3 | 33.1 | 18.3 | 17.7 | 17.4 | 176.2 | 304.5 |
Frontier Oil | 199.6 | 42.7 | 31 | 29.8 | 24.7 | 18 | 1,156.4 |
TGC Industries | 220 | 36.7 | 39.6 | 39.7 | 38.2 | 51.1 | 682.2 |
Data provided by Capital IQ, a division of Standard and Poor's.
All of these companies have increased ROIC every year over the past five years, and their returns have been phenomenal. That's because the companies weren't nearly as valuable back when they had lower ROICs. Their improving businesses caused the market to reassess their true values.
All that sparkles isn't gold
The market, however, is not always an efficient place. It has not yet caught on to every company with a growing ROIC. Take a look at Dell's (Nasdaq: DELL) plight, for example:
Co. | ROIC | ROIC | ROIC | ROIC | ROIC | % Price |
|---|---|---|---|---|---|---|
Dell | 46.3 | 44.9 | 43.8 | 38.6 | 39.6 | (28.4) |
Data provided by Capital IQ, a division of Standard and Poor's.
Dell has trailed the market over the past year and risen by only 12 percent -- essentially moving with the market -- over the past five years, despite the upward slope of its ROIC, which has been consistently higher than that of competitors Sun Microsystems and IBM. In other words, this is an improving business that has not yet been recognized by the market.
Will Dell's stock price finally perform in 2006? No one can say. But given its ability to execute its strategy and improve its business, today's price does look like an attractive long-term entry point.
