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Comparing a company's use of capital to the market pricing of its stock (a/k/a value investing)

 

For the analytical tool referenced in the article below to research competitive use of capital, see

Returns on Corporate Capital (ROCC)

Note that for purposes of research integrity the definition of industry competitors for ROCC analyses is based on the Standard Industrial Classification (SIC) specified by the company itself in its reporting to the SEC. In some cases, users may find it more meaningful to make their own selections of competing companies for comparison.

 

Source: Dow Jones MarketWatch, June 12, 2018 article

A deep look at the stocks held by this money manager Warren Buffett admires

Published: June 12, 2018 10:45 a.m. ET

Here are several screens of stocks held by Lou Simpson’s SQ Advisors

Bloomberg

Valero Energy has been a solid performer through the extended period of low oil prices
 

 

By

Philip

van Doorn


 Investing columnist

 

 

Lou Simpson is a veteran value investor tremendously admired by Warren Buffett. So what can investors learn through a closer look at Simpson’s current holdings, as disclosed in regulatory filings?

For Simpson, value means a company with a track record for good financial performance, along with a relatively low price and low risk. Some can be judged by the numbers, but the rest relies on a more subjective analysis of a company’s position relative to peers and to the opportunities in its industry.

Simpson, a former CEO of Berkshire Hathaway’s BRK.A BRK.B Geico insurance unit and now chairman of SQ Advisors, has said he looks for a high rate of return on invested capital, along with a high cash-flow return and a relatively low ratio of price to cash flow.

As of March 31, SQ Advisors held 15 stocks. Here’s a deeper look at those stocks using some of his criteria.

Return on corporate capital

There are various ways to measure a company’s return on the money that has been invested in it. Return on equity (ROE) only measures operating earnings against how much its shareholders have invested, while return on invested capital (ROIC) measures operating earnings against a company’s equity and long-term debt — pretty much all the money invested in it. The idea is to understand how good a company’s managers are at deploying capital.

But methods of calculating ROIC vary. The Shareholder Forum has developed a similar but uniform measure, return on corporate capital (ROCC), that allows for a quick and free comparison of a company’s numbers to those of its competitors, based the company’s Standard Industrial Classification (SIC), which comes from SEC filings.

ROCC is a company’s annual net income plus interest expense and income taxes, divided by the ending balance of total assets less total liabilities other than interest-bearing debt. It is calculated annually for all publicly traded companies in the U.S. based on annual reports. The idea is a measure how well a company’s management deploys capital for the production of goods and services.

A company’s ROCC is not simply compared to the average ROCC for its SIC group. Instead, a calculation is made for the aggregated assets and income data for the entire SIC group, excluding for the subject company. This means that the industry ROCCs for two companies in the same group may be different.

ROCC is most meaningful within industries, because some are much more capital intensive than others. You can do your own comparisons for free at the Shareholder Forum’s website.

Here are the 15 stocks held by the SQ Advisors as of March 31, along with their five-year average ROCC compared with those of their industry competitors:

Company

Ticker

SIC group

Five-year average ROCC

Five-year average ROCC - industry competitors

Allison Transmission Holdings Inc.

ALSN

Motor Vehicle Parts and Accessories

11.7%

13.3%

Brookfield Asset Management Inc. Class A

BAM.A

N/A

N/A

N/A

Charles Schwab Corp.

SCHW

Security Brokers, Dealers and Flotation Companies

1.3%

0.9%

CarMax, Inc.

KMX

Retail Auto Dealers and Gasoline Stations

7.5%

10.8%

Liberty Global PLC Class C

LBTYK

Cale and Other Pay Television Services

2.2%

11.1%

Cable One Inc.

CABO

Cable and Other Pay Television Services

14.9%

10.1%

Apple Inc.

AAPL

Electronic Computers

28.0%

6.5%

Sensata Technologies Holding PLC

ST

Industrial Instruments for Measurement, Display and Control

8.4%

10.9%

Tyler Technologies Inc.

TYL

Services - Prepackaged Software

18.2%

12.6%

Charter Communications Inc. Class A

CHTR

Cable and Other Pay Television Services

3.4%

11.0%

Berkshire Hathaway Inc. Class B

BRK.B

Fire, Marine and Casualty Insurance

5.9%

2.8%

Liberty Broadband Corp. Class C

LBRDK

Cable and Other Pay Television Services

5.1%

10.1%

Axalta Coating Systems Ltd.

AXTA

Paints, Varnishes, Lacquers, Enamels and Allied Products

4.3%

16.8%

SBA Communications Corp. Class A

SBAC

Real Estate Investment Trusts

4.4%

4.0%

Hexcel Corp.

HXL

Plastics, Materials, Synth Resins and Nonvolcan Elastomers

16.7%

15.3%

Source: SEC 13-F filing for March 31, 2018; the Shareholder Forum

ROCC calculations aren’t available for Brookfield Asset Management because it is registered in Canada and does not file standard 10-K annual reports with the SEC.

Out of the 14 companies for which the calculations are available, only eight have five-year average ROCC that are higher than those of their competitors. Apple AAPL, Cable One CABO, Tyler Technologies TYL, and Berkshire Hathaway have greatly outperformed their competitors on this basis.

Price to free cash flow

A look at valuations relative to free cash flow may paint a different value picture for the companies whose ROCC came in below those of their competitors.

A company’s free cash flow is its remaining cash flow after planned capital expenditures. It is money that can be used for expansion, acquisitions, dividends, buybacks or other corporate purposes. The S&P 500 SPX has a weighted ratio of price to free cash flow of 20.4 (excluding companies with negative cash flow), based on the closing share price on June 8 and data for the past 12 reported months, according to FactSet. About half of SQ’s 15 stocks top that, as this table shows:

Company

Ticker

Closing price - June 8

Free cash flow per share - past 12 months

Price/ Free cash flow

Allison Transmission Holdings Inc.

ALSN

$42.04

$4.34

9.7

Brookfield Asset Management Inc. Class A

BAM.A

$53.40

$4.08

13.1

Charles Schwab Corp.

SCHW

$57.73

-$4.30

N/A

CarMax, Inc.

KMX

$73.79

-$2.07

N/A

Liberty Global PLC Class C

LBTYK

$28.35

$4.99

5.7

Cable One Inc.

CABO

$681.62

$27.24

25.0

Apple Inc.

AAPL

$191.70

$10.71

17.9

Sensata Technologies Holding PLC

ST

$53.85

$2.42

22.2

Tyler Technologies Inc.

TYL

$231.70

$4.02

57.7

Charter Communications Inc. Class A

CHTR

$277.26

$10.36

26.8

Berkshire Hathaway Inc. Class B

BRK.B

$196.01

$9.36

21.0

Liberty Broadband Corp. Class C

LBRDK

$72.90

-$0.13

N/A

Axalta Coating Systems Ltd.

AXTA

$31.85

$1.59

20.0

SBA Communications Corp. Class A

SBAC

$157.32

$5.77

27.3

Hexcel Corp.

HXL

$73.09

$2.03

36.0

Source: SEC 13-F filing for March 31, 2018; FactSet

Three have negative total free cash flow over the past 12 months. Two — Charles Schwab SCHW and Liberty Broadband LBRDK — have also had negative free cash flow for the most recent reported quarters. This indicates heavy investment by these companies, and Simpson’s stakes suggest confidence that the investments will pay off over the long term.

Wall Street sentiment

One thing Simpson assuredly does not rely on is the opinion of sell-side analysts. Stocks ratings from analysts who provide reports to brokerage customers skew toward the positive. In fact, a recent look at the S&P 500 showed that there were no companies with majority ‘sell’ or equivalent ratings among analysts.

But it’s still worth looking at which stocks are being pumped the most by analysts. So here are ratings summaries and price targets for the 15 stocks:

Company

Ticker

Share 'buy' ratings

Share neutral ratings

Share ‘sell’ ratings

Closing Price - June 8

Consensus price target

Implied upside potential

Allison Transmission Holdings Inc.

ALSN

40%

47%

13%

$42.04

$44.86

7%

Brookfield Asset Management Inc. Class A

BAM

86%

14%

0%

$53.40

$61.88

16%

Charles Schwab Corp.

SCHW

64%

32%

5%

$57.73

$61.21

6%

CarMax Inc.

KMX  

55%

35%

10%

$73.79

$73.53

0%

Liberty Global PLC Class C

LBTYK

78%

11%

11%

$28.35

$38.83

37%

Cable One Inc.

CABO

33%

34%

33%

$681.62

$716.20

5%

Apple Inc.

AAPL

60%

40%

0%

$191.70

$198.74

4%

Sensata Technologies Holding PLC

ST

37%

63%

0%

$53.85

$58.33

8%

Tyler Technologies Inc.

TYL

58%

42%

0%

$231.70

$225.70

-3%

Charter Communications, Inc. Class A

CHTR

72%

25%

3%

$277.26

$376.44

36%

Berkshire Hathaway Inc. Class B

BRK.B

63%

38%

0%

$196.01

$233.27

19%

Liberty Broadband Corp. Class C

LBRDK

83%

17%

0%

$72.90

$105.00

44%

Axalta Coating Systems Ltd.

AXTA

37%

63%

0%

$31.85

$34.33

8%

SBA Communications Corp. Class A

SBAC

68%

32%

0%

$157.32

$181.76

16%

Hexcel Corp.

HXL

33%

67%

0%

$73.09

$72.54

-1%

Sources FactSet

It’s not surprising that the analysts’ ratings lean positive, because that is how the industry is geared. The price targets are for 12 months, which no doubt is considered a short period by Simpson.

The bottom line

The data tell us two things: Simpson is looking out several years for many of these companies, and subjective analysis of a company’s competitiveness and current investments is critical to his successful investing style.

In contrast, Wall Street analysts and the financial media are much more focused on quarterly and annual results — and Wall Street’s one-year horizon really is a short period for a serious long-term investor.

At a time when value investing has been out of style and the S&P 500’s performance has been driven by technology plays, particularly the so-called FAANG stocks (Facebook, Amazon, Apple, Nextflix and Google parent Alphabet) Simpson’s investments have done well.

The S&P 500 returned 22% in 2017; eight of his plays did as well or better. One of the laggards, CarMax, is a 2018 acquisition, and two others were bought toward the end of 2017. For three years through June 8, the S&P’s return was 34%.

Here are total returns for the 15 stocks going back three years, as well as returns from the end of the quarter when SQ Advisors either initially purchased the shares, according to FactSet, or the fourth quarter of 2011, after which the firm began filing lists of its stock holdings with the SEC:

Company

Ticker

Total return - 2018 through June 8

Total return - 2017

Total return - 3 years

End of quarter stock initially purchased

Total return since quarter end of initial purchase through June 8

Allison Transmission Holdings Inc.

ALSN

-2%

30%

46%

6/30/2016

54%

Brookfield Asset Management Inc. Class A

BAM.A

-2%

26%

34%

6/30/2012

174%

Charles Schwab Corp.

SCHW

13%

31%

79%

12/31/2011

449%

CarMax Inc.

KMX

15%

0%

2%

3/31/1018

19%

Liberty Global PLC Class C

LBTYK

-16%

14%

-33%

9/30/2014

-14%

Cable One Inc.

CABO

-3%

14%

N/A

9/30/2016

19%

Apple Inc.

AAPL

14%

48%

58%

12/31/2016

70%

Sensata Technologies Holding PLC

ST

5%

31%

-3%

9/30/2016

39%

Tyler Technologies Inc.

TYL

31%

24%

92%

12/31/2016

62%

Charter Communications, Inc. Class A

CHTR

-17%

17%

47%

12/31/2017

-17%

Berkshire Hathaway Inc. Class B

BRK.B

-1%

22%

40%

12/31/2011

157%

Liberty Broadband Corp. Class C

LBRDK

-14%

15%

40%

12/31/2017

-14%

Axalta Coating Systems Ltd.

AXTA

-2%

19%

-8%

9/30/2016

13%

SBA Communications Corp. Class A

SBAC

-4%

58%

35%

3/31/2017

31%

Hexcel Corp.

HXL

19%

21%

53%

12/31/2016

44%

Source: FactSet

The firm reports its stock holdings as of the end of each quarter, So the returns in the right-most column do not incorporate any additional purchases or any sales since that date. We also don’t know if SQ Advisors has sold any shares since March 31.

 

Philip

van Doorn

Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.

 

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