Some swear the market is about to go on a tearing rally and stay in a bull market for the foreseeable future; others say that the Federal Reserve is only entertaining rate cuts, preparing to cushion some economic crash soon.
While nobody other than Warren Buffett holds a crystal ball, there are ways that you can prepare yourself and your wealth to beat the market long term.
How do value investors begin their journey of stock picking to ensure they are positioned into the best names? It begins with profitability measures.
Return on equity (ROE) and return on invested capital (ROIC) metrics and their rates will tell you most of what you need to know about a business’ strength and longevity.
Year after year, American Express’ financials show an ROE range between 32% and 35.7%, which is incredible by any means of analysis.
In theory and often in practice, this means that each dollar of equity (stock) you invest into this business will return 32% to 35.7% back to you each year, whether that is through appreciation or buying back stock. Not a bad way to compound your wealth while the market figures out its direction.
Home Depot made it into this profitable category; construction contractors and DIY home renovators depend on this deeply entrenched brand to fulfill their needs. This consumer loyalty and able management teams enabled the business to generate ROIC rates between 27.4% and 31.5% over the past five years.
Following this unique positioning in the industry allows the company to consistently make ROIC rates between 20.7% and 23.8%, speaking to the management’s ability to run this ship. These types of returns on capital can only bring the long-term direction of the stocks in one way: up.
Now that you understand what makes these companies great choices for value investment, perform the second step in the value investor’s bible.
Understanding the certainty of the future earning power of the business in question can help you better decide what that stock could be worth today.
In financial stocks, American Express needs to stand out regarding growth projections. Analysts see a 10.8% jump in earnings per share for the next 12 months, but keep in mind that 10.8% on $11 EPS is much better than 20% growth on $2 EPS.
For Home Depot, there is an even less exciting projection for EPS, with only 3.9% expected growth for the next 12 months. However, this giant $320 billion company generates $15.6 in EPS, so that “small” growth rate still goes a long way when it comes to price action.
Last but not least, UPS analysts are confident about putting out a 7.3% growth projection. With a price target set at $188.9, there is an implied 16.4% upside from today’s stock price. Staying true to the value school of returns, 7.3% growth on a $133 billion company can do wonders for you.
Betting on a brand name is a fairy tale, and investing in numbers alone places your faith in a spreadsheet. However, when you combine the two, you get a perfect mix of great businesses.
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