When investors look to find the next big opportunity to invest their capital, they often focus on what’s popular at the time or having the best price action in the so-called “popularity contest” that both Warren Buffett and Keynes referred to in their work. They also mentioned that the market eventually becomes a weighing machine, turning into facts and away from these popularity measures.
Speaking of Warren Buffett, there is one significant weight he takes into account when choosing his next investment. Apart from the deep qualitative analysis of management and product quality, Warren Buffett likes to see a high return on invested capital (ROIC) rate accompanied by a relatively low valuation metric such as price-to-earnings (P/E) or a discount to book.
Today’s list carries three stocks that will enable investors to tap into the compounding wonders of companies with high ROIC rates, making them long-term holds in any portfolio for the coming years. Names like Mastercard Inc. (NYSE: MA) for the financial sector, Ulta Beauty Inc. (NASDAQ: ULTA) for the consumer staples sector, and even Alphabet Inc. (NASDAQ: GOOGL) for one of the best names to consider in the technology sector.
Breaking Down Mastercard Stock’s Long-Term Potential
As long as a financial system is in place, which includes consumer credit or some derivative close to it, stocks like Mastercard will see expanding activity and success. The reasoning behind Mastercard's optimistic view comes from the understanding that today, more than ever, consumers depend on credit availability.
That's as far as the qualitative end of the analysis goes; for the quantitative, this is a stock that made it to the Buffett portfolio for a reason. The company's financials show a massive 55% ROIC for the past 12 months, a profitability level credited to the brand's market share and pricing power with vendors and customers.
This high ROIC has driven Mastercard stock to a 3,500% run since the financial crisis of 2008. Meanwhile, the broader S&P 500 index has only had a 524% run, even with the recovery shortly after the crisis. Now, investors understand the importance of having companies with high ROIC rates for wealth compounding.
Wall Street analysts, namely those at Keefe, Bruyette & Woods, think Mastercard stock deserves an outperform rating and a $618 price target today. To prove these valuations right, the stock would have to stage a rally of up to 17% from where it trades today, the momentum likely to continue for the coming years.
Ulta’s Customer Loyalty Drives a Compounding Stock
Most people think that makeup and skincare products are discretionary. Still, the data in Ulta’s financials would show that they are more fit to be staples, as Ulta has never had a net loss in its income statement, even through the 2008 financial crisis. Driving this strong profit moat is one metric that investors should always keep in mind for this company.
Over 90% of sales come from Ulta’s customer loyalty programs, unseen in the retail space. This allows management to improve their sales forecasts and also manage inventory accordingly since they have data on all the buying habits of most of their customers. Efficiently managing these metrics leads to the best part of Ulta’s business.
That is a 28% ROIC over the past 12 months. Whether the economy is booming or busting, Ulta’s customers will likely always make room in their budgets for skincare and makeup products, making this level of profitability almost a given for the coming years.
When it comes to price action, investors can see the benefits of this high ROIC. Since the financial crisis, Ulta stock has delivered a massive 4,100% run, outpacing the S&P 500 and its 524% performance by nearly tenfold. Assuming this ROIC stays at the current range, the next few decades could look just like the past, if not better.
Alphabet Stock: Unmissable Compound Opportunity
Google, owned by parent company Alphabet, is not only the largest search engine and video streaming platform in the world, but it is also home to most of the online advertising budgets and is now a leader in developments for quantum computing through its newest Willow computer chip.
All of these moats act as Alphabet’s predictable model, where management can more efficiently allocate capital and manage projects more intensely. This theme is translated into the company’s financials today. Alphabet delivered an ROIC rate of up to 27.8% over the past 12 months, an incredible feat for a company that trades at a $2.4 trillion valuation today.
It is no wonder that Alphabet has posted a rally of 1,600% since the financial crisis, outperforming the S&P 500, as another perfect example for investors to consider the massive importance of businesses with high ROIC rates. This metric should be a top priority to compound their wealth from here, as annual stock prices tend to match it over the long term.