A Search For Future Multi-Baggers By Tracking Past Shareholder Wealth Creation

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Includes: BA, BEAV, COL, ESL, HEI, JBFCY, MOG.A, ROST, TDG, TGI, UTX
by: The Value Pendulum

Summary

Shareholder wealth compounders are stocks which have earned investors an annualized return of minimum 20%, irrespective of whether they bought the stock 3 years, 5 years or 10 years ago.

These stocks are also multi-bagger investments for their shareholders, a 20% annualized return over a decade implies that their stock prices grew at least six-fold.

There are approximately 130 stocks listed in the U.S. and Asia which will meet the definition of shareholder wealth compounders, and I profile four of them.

Screens And Compounders

I generate ideas from multiple sources including, but not limited to, insider trades, 13Fs, fund manager letters, analyst reports, blogs, forums, but quantitative screens are my favorite considering their unbiased nature. However, I have to admit that it is comparatively more challenging to search for wide-moat compounders or multi-baggers in a quantitative manner compared with deep-value cigar-butts. The current quantitative screens I use in my search for quality stocks include Joel Greenblatt's Magic Formula and stocks which have delivered at least 15% ROE for every year in the past decade.

John Huber, portfolio manager of Saber Capital Management, LLC, and author of the Base Hit Investing blog, shared an unique and unconventional screen in his blog post titled "Quality Screens: Part 1." He calls the screen "Stock Price Compounders" which is basically "a list of stocks that have grown 10% a year for the last 10-15 years." This is a significant departure from the 52-week lows filter which most value investors will be familiar with. I wrote about Walter Schloss' Rule No. 10 on buying a stock near the low of the past few years in an article published here.

Intuitively, the "Stock Price Compounders" screen makes a lot of sense, since the companies on the list must have done something right to outperform its peers in terms of share price performance over an extended time period and there is every reason to believe that this might potentially continue into the future. The caveat, as it applies with most other quantitative screens to filter for quality companies, is that the past is not necessarily a good predictor of the future and mean reversion tends to come into play sooner or later (although it can be argued that a decade is a long time).

I have modified John Huber's "Stock Price Compounders" screen slightly; I am looking for stocks which have earned investors an annualized return of at least 20%, irrespective of whether they bought the stock 3 years, 5 years or 10 years ago, I call them "Shareholder Wealth Compounders." These stocks are also multi-bagger investments for their shareholders. A 20% annualized return over a decade implies that their stock prices grew at least six-fold.

There are approximately 130 stocks listed in the U.S. and Asia which will meet the definition of shareholder wealth compounders, and I profile four of them below detailing their moats and future growth runways.

Shareholder Wealth Compounder 1: TransDigm Group (NYSE:TDG)

In the company's most recent investor presentation, TransDigm, a supplier of highly engineered aircraft components for use on commercial and military aircraft, states that its objective is to achieve "Private Equity-Like Growth in Value with Liquidity of a Public Market." It has passed its own test with flying colors, boasting annualized share price returns of 28.8%, 29.1% and 29.9% for the 3-year, 5-year and 10-year holding periods respectively. This compares favorably with the 10-year return CAGR of 6% and 10% for the S&P 500 and its listed aerospace peers (BE Aerospace (NASDAQ:BEAV), Boeing (NYSE:BA), Esterline (NYSE:ESL), Heico (NYSE:HEI), Moog (NYSE:MOG.A), Rockwell Collins (NYSE:COL), Triumph (NYSE:TGI) and United Technologies (NYSE:UTX)) respectively. TransDigm's share price return also parallels its revenue and EBITDA 10-year CAGRs in excess of 20%.

TransDigm's moat lies with high entry barriers and significant switching costs. The requirement to be certified or qualified by regulatory agencies and OEMs deters new entrants in the highly engineered aircraft components market. Meanwhile, the high cost of aircraft failure weighed against the benefit of cost savings with alternative suppliers works in TransDigm's favor. Furthermore, there is a "razor-and-blade" model at work here, with its installed base of approximately 95,000 aircraft as of end-2015. This is validated by the fact that approximately 80% of TransDigm's revenues are generated from products for which it is the sole source provider.

TransDigm highlights organic EBITDA growth, leverage and acquisitions as its key growth drivers. Given that TransDigm holds only a mere 4% market share for its addressable (market where TDG currently has content on by aircraft model and part type) market for commercial aftermarket, TransDigm has a long growth runway ahead of itself to capitalize on global passenger traffic growth. TransDigm has completed the acquisition of 57 businesses since its inception in 1993, and its continued focus on targets running proprietary, sole-source aerospace businesses with significant aftermarket should drive future shareholder value creation.

Shareholder Wealth Compounder 2: Ross Stores (NASDAQ:ROST)

Ross Stores is a "off-price retailer" for branded apparel and accessories, with around 1,400 stores concentrated in the western half of the US. As the name "off-price" suggests, Ross Stores offers its customers low prices by buying overruns and unsold inventory from apparel manufacturers and providing a frills-free shopping experience. It has generated ROEs in excess of 20% for every year in the past 15 years and positive free cash every year, while growing revenue, EBITDA and EPS by 10-year CAGRs of 13%, 21% and 23% respectively over the same period. Ross Stores boasts annualized share price returns of 22.0%, 25.9% and 26.1% for the 3-year, 5-year and 10-year holding periods respectively.

There are two key factors contributing to Ross Stores' wide moat. Firstly, Ross Stores is only one of two off-price retailers along with TJX Companies (NYSE:TJX) with the scale economies to compete in the space. ROST has significant bargaining power - it can get the best selection of apparel at the best prices simply because apparel manufacturers want to get rid of their excess inventories fast and without any hassle, which means they will turn to the largest players like ROST. Furthermore, ROST benefits from economies of scale, as it can spread selling, general & administrative expenses over a significantly larger revenue base (relative to its peers) either to expand margins or reinvest to widen its moat (and market leadership). Secondly, the back-end is equally important as the front-end, if not more so, when it comes to retail. Ross Stores' opportunistic buying is only made possible with the support of a large and growing off-price buying organization sourcing product from thousands of manufacturers and vendors and its strategically located buying offices in New York City and Los Angeles.

Ross Stores has the long-term potential to eventually reach 2,500 stores, compared with its current store footprint of under 1,500 and TJX's 3,000-plus stores. Store expansion plans will be realized as ROST expands its reach to Northeast and Midwest U.S. In addition, the consumer shift from department stores to "off-price" is a secular trend that still has legs to run for the foreseeable future.

Shareholder Wealth Compounder 3: Jollibee Foods Corporation (OTCPK:JBFCY) (JFC PM)

Philippines-listed Jollibee Foods, the equivalent of McDonald's (NYSE:MCD) and KFC in its home market, boasts annualized share price returns of 20.8%, 24.6% and 23.6% for the 3-year, 5-year and 10-year holding periods respectively.

Jollibee's mascot, a gigantic bee wearing a chef's hat, is probably as recognizable as Ronald McDonald and Colonel Sanders in the Philippines. A Financial Times survey conducted in October 2015 indicated that 54% of Filipino respondents frequently visited Jollibee, compared with 42% and 17% for McDonald's and KFC respectively. Jollibee's edge over foreign competitors includes lower price-points and its ability to customize its menu to cater to local tastes.

According to an article in the local Philippine Daily Inquirer titled "Top Filipino firms building Asean empires," Jollibee has set an ambitious target of becoming among the world's five largest quick-service restaurants in seven years' time. Jollibee already has more than half the market share in its home country, so future growth has to come from overseas markets (accounting for close to a quarter of sales currently) such as Vietnam and China.

Shareholder Wealth Compounder 4: Straco Corporation (STCO SP)

Singapore listed Straco, the operator of several tourist attractions in China and Singapore, boasts annualized share price returns of 43.4%, 38.8% and 22.8% for the 3-year, 5-year and 10-year holding periods respectively.

Straco's moat is similar to that of other theme park operators. Interested readers are advised to refer to my article titled "Wide Moat Business Type Series: Theme Park Operators" to learn more about the attractiveness of such businesses with respect to high barriers to entry, strong pricing power and prodigious free cash flow generation.

Straco is a proxy for the long-term growth in China's middle-income population and domestic tourism. A near-term growth catalyst for Straco is the opening of Disneyland in Shanghai in June 2016, which should benefit Straco's flagship Shanghai Ocean Aquarium as tourists are likely to visit multiple attractions on their Shanghai trip.

Closing Thoughts

There are more than ways than one to skin a cat. I typically source potential multi-baggers from a list of "Magic Formula" stocks, wide moat compounders, hidden champions and high quality businesses with a track record of consistent profitability and free cash flow generation, but there are many other pathways.

In his book "100 Baggers" which detailed his journey of creating a database of every 100-bagger from 1962 through 2014, Chris Mayer highlights lots of growth and a low multiple as the twin engines of 100-baggers. A July 2016 UBS research report titled "A search for 'multiple-baggers'," found that Hong Kong- and China-listed multi-baggers have typically increased earnings by at least 30% per year and started with market capitalizations under $500 million.

As a bonus for my subscribers of my premium research service, they will get access to the complete list of over 130 shareholder wealth compounders in a separate bonus watchlist article to be published in the next few days.

For investors interested in other wide-moat and deep-value stocks listed in the U.S. and Asia, please consider my Asia/U.S. Deep-Value Wide Moat Stocks exclusive research service.

You can preview my service at no cost via a 2-week free trial; here is a link to sign up for free here.

Asia/U.S. Deep-Value Wide Moat Stocks Premium Research

Subscribers to my Asia/U.S. Deep-Value Wide Moat Stocks exclusive research service get full access to the list of deep-value and wide moat investment candidates and value traps, including "Magic Formula" stocks, wide moat compounders, hidden champions, high quality businesses, net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts.

Some of the potential investment candidates I profiled for my subscribers in July 2016 include the following: 1) a U.S.-listed investment holding company whose stub is trading significantly below book value and where the downside is protected by the value of hard assets on the balance sheet, 2) an Asian-listed deep-value stock trading at slightly above half times book value offering close to a 5% dividend yield with significant cash inflow expected in the future resulting from the gradual monetization of a key asset, 3) an Asian-listed net-net with insiders owning more than 70% of the company and a well-known and respected value investment firm as a shareholder, 4) a U.S.-listed wide moat stock with a long growth runway where Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) and First Eagle Investment are shareholders, 5) an Asian-listed hidden champion and Magic Formula stock boasting a dominant leadership position in both its home market and a key foreign market. It is a forward-looking company, which was among the first few companies to venture outside of its home market in the late 1950s and 1960s, and also a product innovator that has pioneered certain new product categories.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.