One of my eureka moments as an investor was when I really began to understand profitability. Not just profit margins, but the concept of return on capital employed and how this supports the process of creating shareholder returns and sustainable growth.
In his recent multibagger webinar, Ed also highlighted return on capital employed as one of the key factors that’s normally required for long-term compounding. Alongside this, one other trait common to most of the big multibaggers in Stockopedia’s database was that they started out with quite reasonable valuations.
Ed explained both of these factors in detail in last week’s masterclass, “The Engines of Multibaggers”, which I’d strongly recommend.
Obviously, I have no objection to holding some multibaggers in my portfolio. But as a dividend growth investor, I also want my portfolio to contain a proportion of more mature companies that are able to pay out attractive levels of surplus cash as dividends.
For this reason, I aim to own a mix of companies split across the top two categories in this chart, which I’ve lifted from the masterclass slides:
With this in mind, I thought it would be interesting to try building a simple screen to look for high-ROCE companies that might be either cash cows or compounding machines.
For the avoidance of doubt, I’m not suggesting all the firms in my screen results are potential multibaggers (although some might be). But in general, I think that investing in highly profitable and cash-generative businesses is likely to lead to an acceptable outcome for shareholders, even if they don’t multibag.
High returns at a reasonable price
I won’t spend too much time talking about the construction of this screen, as it’s fairly simple and I’ve discussed how I build screens many times before. Here’s a recent example.
This is the screen I’ve created to try and find shares with high returns on capital employed and reasonable valuations:
You can see/copy my High Returns at a Reasonable Price screen here
The rules are quite simple and there are certainly plenty of ways this screen could be changed or perhaps refined. But as always, this is only intended to be a starting point for further investigation. I don’t want the criteria to be…
