As value investors we know that in the long run it is the operating performance of a company that will determine the future value. We are primarily looking for companies with a moat, and one thing that may indicate a moat is a 10 year history of ROIC above 10% Lets see what we can find out from this example. (Metro inc.)
This company steadily produced wonderful results until 2018. What happened then? It turns out they bought another company, in this case a drugstore. The result is that shareholders suffers from lower returns, while the CEO gets named CEO of the year. He probably also received a raise since the company is bigger.
Mr. Market however, seems quite happy:
So, even though the owners got a bad deal, and the company is less profitable, its stock price continued to rise. The way I read this, is that the moat of the company has been breached by bad decision making of the management. And thus I’ll stay away. ROIC is the main driver of value creation. But according to a 2013 McKinsey survey found that only 16% of CEOs understood how their company created value(!)
Now, let’s compare with this:
The results here is absolutely fantastic. The company keeps on cranking out cash, year after year. Comparing ROIC with ROE gives me a suspicion that the company has added more debt the last years. (With no debt roe and roic should be equal.)
A quick look at the balance sheet confirms this.
However, with a cash flow of above 8 bn a year, the entire debt could be payed down with less than two years free cash flow. So this debt is not dangerous. But as you probably suspect now, the price of this company is not cheap. And it will probably not be in the foreseeable future. But with this kind of operating performance, even if you pay too much, time will most likely be your friend, and give you a positive result. I’ll add this last one to my watch list, and if it drops somewhat during a market sell off, I’ll be ready to buy big time.
valueinvestor 