The ratio of return on invested capital (ROIC) compared to weighted average cost of capital (WACC) is an excellent way to determine which companies are best at maintaining and growing their profitability. The higher the ROIC, the more efficient the company is at turning invested dollars into profits. Since profits tend to drive share prices, investors should seek out those names with a high ROIC, as this is likely to lead to further earnings growth and increase the chances of share price appreciation. For dividend growth investors, a high ROIC can also lead to high levels of dividend growth.
At the same time, investors will also want to look for companies that are keeping their WACC low. WACC is the cost of financing a company's operations and investments; if the WACC is higher than the ROIC, it menas that the company is destroying value rather than creating it.
For example, if a company is generating ROIC of 20% and WACC of 10%, then it is generating 10 cents of value for every dollar that it invests (i.e. 10%). ROIC doesn’t mean much if it is below the WACC as the firm as eroding value. Another factor to consider is how value creation for a company compares against its peer group. Companies creating more value than the competition can be considered stronger overall.
In this article, we will examine four companies with a five-year median ROIC of at least 20%, a WACC below 8.5% and a dividend yield greater than 1.5% to see if they represent attractive investment opportunities.
Amgen
Amgen Inc. (AMGN, Financial) is the largest independent biotech company in the world. It engages in the discovery, development and manufacturing of medicines in the key areas of oncology, cardiovascular disease and inflammation. The company has annual revenues exceeding $26 billion and is valued at $137 billion today.
Amgen has a five-year median ROIC of 20.9% and a WACC of 4.7%, meaning that for every dollar that the company invests, it is creating more than 16 cents of value. For context, this is a superior value creation compared to AbbVie Inc. (ABBV) and Johnson & Johnson (JNJ), which create 11 cents and 10 cents of value, respectively, for every invested dollar.
The company has used its valuation creation over the long-term to drive meaningful earnings growth. Earnings per share have compounded at an annual rate of 12.2% since 2011. Amgen has also reduced its share count by more than 3% per year over the last decade while net profit has doubled. Amgen has increased its dividend with a compound annual growth rate of nearly 28% from 2011 through 2020, making it one of the most shareholder friendly companies in the market. Shares now yield 2.8%, twice the average yield of the S&P 500.
Amgen trades with a share price of $239 at the moment and has a GF Value of $248.69, resulting in a price-to-GF-Value rato of 0.96. The company has a rating of fairly valued from GuruFocus.
Colgate-Palmolive
Colgate-Palmolive Company (CL, Financial) is a leading maker and distributor of toiletries and other household products. The company’s top brands include Colgate toothpaste, Palmolive soaps, Mennen shave cream and Hill’s pet foods brands. Colgate-Palmolive has a market capitalization of almost $69 billion and generated $16.5 billion of revenue in 2020.
The company has a ROIC of 28.8% and a WACC of 4.8%, equating to 24 cents of value creation for every dollar invested. This compares favorably to Kimberly-Clark Corp (KMB), which has value creation of almost 17 cents per dollar, and the Clorox Company (CLX), which has value creation of just under 19 cents for every dollar invested.
Colgate-Palmolive is a good example of a slow and steady consumer staples company as earnings per share have increased at an annual rate of 2.4% for the 2011 to 2020 time period. The company’s dividend has increased for 58 consecutive years, making Colgate-Palmolive one of just 30 or so names with the necessary 50+ years of growth to qualify as a Dividend King. The stock yields 2.2%.
Colgate-Palmolive currently trades hands at approximately $81 dollars per share. The stock has a GF Value of $73.02, giving it a price-to-GF-Value ratio of 1.11. Colgate-Palmolive has a rating of fairly valued.
Starbucks
Starbucks Corporation (SBUX, Financial) has a store of count of almost 33,000, giving the company one of the largest restaurant footprints in the world. The cafe chain company has a market value of $129 billion and had sales of $23.5 billion in fiscal year 2020. Starbucks’ fiscal year ends the Sunday closest to Sept. 30.
Starbucks has a ROIC of 22.7% and a WACC of 6.5%. For every dollar that the company invests, it creates just over 16 cents in value. This matches the value creation of peer McDonald’s Corporation (MCD), the only other restaurant to meet the minimum requirements of the search perimeters. This speaks to the difficulty of turning a profit in the restaurant industry.
Earnings per share compounded at a rate of only 4.4% annually over the last decade. However, I believe the company deserves some slack due to the negative effects of the pandemic. Using the 10-year period ending in fiscal year 2019, earnings per share have an annual growth rate of 16%. The company has raised its dividend for 10 consecutive years and has a dividend compound annual growth rate of nearly 30% over this period of time.
Shares of Starbucks trade at $112 apiece as of the writing of this article, and the stock has a GF Value of $87.44, resulting in a price-to-GF-Value ratio of 1.28. Shares are rated as modestly overvalued.
T. Rowe Price
With $1.52 trillion of assets under management, T. Rowe Price Group (TROW, Financial) is one of the largest publicly traded investment advisory companies in the world. The company offers no-load mutual funds, private accounts and sponsored investment products. T. Rowe Price is valued at $43 billion and has annual revenues in excess of $6 billion.
T. Rowe Price has a ROIC of 27.5%, one of the highest scores in the asset management industry. Its WACC is 8.3%, resulting in just over 19 cents of value creation for every $1 invested. For reference, peer Apollo Global Management Inc. (APO) generates 16 cents of value for every dollar invested.
Earnings per share have compounded at a rate of 12.6% per year for the last decade while net profit has nearly tripled. The company maintains a dividend growth streak of 35 years and has raised its dividend an average of more than 11% a year since 2011. Investors are being paid a 2.2% yield to own the name.
T. Rowe Price is trading at just under $200 per share. The stock has a GF Value of $154.47, giving the stock a price-to-GF-Value ratio of 1.29 and earning the name a rating of modestly overvalued.
Final thoughts
Investors can use return on invested capital and weighted average cost of capital to help determine which companies are creating value for shareholders. Amgen, Colgate-Palmolive, Starbucks and T. Rowe Price are not only creating high levels of value for shareholders, they are doing so at a better clip than the majority of their peers.
Of the four stocks discussed here, just Amgen is trading below its GF Value, implying that the other names have gotten ahead of their intrinsic values. However, when it comes to quality, companies outperforming peers in terms of value creation are worth at lot, in my opinion. I am a believer in buying the best names in an industry. Therefore, I find Amgen, Colgate-Palmolive, Starbucks and T. Rowe Price to be buys today as their quality is second to none in their respective industries.
Author disclosure: the author maintains a long position in Amgen, Starbucks, AbbVie, Johnson & Johnson, Kimberly-Clark and McDonald’s.
