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James Li
James Li
Articles (427)  | Author's Website |

Good Companies Model Portfolio Achieves Twice the Return of the S&P 500

Buying good companies generates good returns

We are pleased to announce that the Good Companies, as described in “Invest Like a Guru,” have outperformed the Standard & Poor’s 500 index by approximately 18.71% since the Aug. 5, 2016, inception date. The model portfolio’s top five gainers were Heico Corp. (NYSE:HEI)(NYSE:HEI.A), Old Dominion Freight Lines (NASDAQ:ODFL), AMETEK Inc. (NYSE:AME), Nathan’s Famous Inc. (NASDAQ:NATH) and Exponent Inc. (NASDAQ:EXPO).

What makes a good company?

Chapter 3 of “Invest Like a Guru” describes three fundamental characteristics of good companies:

  1. The company is “consistently profitable at decent and stable profit margins” regardless of the state of economy.
  2. The company has a high return on invested capital and is not “asset-heavy” or “capital-intensive.”
  3. The company is “continuously growing its revenue and earnings.”

As discussed in a previous article, the Good Companies screener includes companies that meet all of the above criteria.

Consistent profitability is critical

Berkshire Hathaway Inc. (NYSE:BRK.A)(NYSE:BRK.B) co-managers Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) stressed the importance of “consistent revenue and earnings growth” in their four-criterion investing approach. Fundamental characteristics one and three usually go hand-in-hand with each other: a company that can continuously grow its revenue and earnings will most likely have consistent profitability, and vice versa.

The Good Companies screener considers just the companies that have a history of profitability over the past 10 years and a GuruFocus business predictability rank of at least two stars. Figure 1 shows Heico’s revenue and earnings trends over the past decade.

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Figure 1

Key profitability characteristics also include the “common-size analysis” ratios, including operating margin and net margin. Heico’s positive investing signs include expanding operating margins, one key indicator of consistent profitability. Figure 2 shows Heico’s profit margin trends over the past 10 years.

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Figure 2

The screener also requires the following three criteria:

  • Positive operating margin growth rate and 10-year median operating margin of at least 16%.
  • 10-year revenue growth rate between 8% and 20%.
  • 10-year earnings growth rate between 10% and 20%.

Company must be asset-light and have good returns on capital

According to the book, asset-light companies can generate higher returns on capital as the lower capital expenditures yield higher free cash flow. The Good Companies screener requires a 10-year average return on capital of at least 14%. Figure 3 shows Heico’s historical return on capital trends over the past 10 years.

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Figure 3

Good companies offer good value potential

Heico, the top performer in the portfolio, gained over 200% since the model portfolio’s inception. Old Dominion and AMETEK gained approximately 100% and 60% over the same time frame.

Premium members have full access to our All-in-one Screener, which allows you to screen for good companies based on an investing strategy. You can either use one of our predefined screeners or create your own screener. Our premium membership also allows you to view stocks on our most popular value screeners, including the Undervalued Predictable Screener, the Buffett-Munger Screener and the Historical Low Price-Sales Screener.

You can also expand your data coverage by subscribing to additional regions like Canada, Asia and Europe. Please also consider purchasing our value investing book, “Invest Like a Guru.”

Disclosure: No positions.

About the author:

James Li
I am an editorial assistant and researcher at GuruFocus. I have a Master's in Finance from SMU, and I enjoy writing reports on financial trends and investor portfolios. Follow me on Twitter at @JamesLiGuru!

Visit James Li's Website


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