5 Munger Stocks: Quality + Growth

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Includes: BKNG, LSTR, REGN, ULTA, UNH
by: Brian Yu
Summary

I consider these five companies I list in the articles to be high-quality growth companies.

Under the PEG rule, they are fairly valued, so I rate them as neutral since I am more interested in undervalued "Munger" stocks.

Understanding their moats is a critical part of being a successful long term outperforming growth investor.

There are five simple critieria I use to understand how to buy great growth stocks at reasonable prices.

The purpose of this article is not to convince readers to buy or sell, but to give actionable steps to being a successful GARP investor.

The Enterprising Investor Series #9: Five Munger Stocks

My next article will be the last article for my “Enterprising Investors” series. I plan on taking a break from the EI series and starting the “Defensive Investor” Series soon. The DI series will focus on passive investing and asset allocation.

How to Outperform as a Growth Investor: Five Companies & Five Criterias

Munger Stocks = Quality + Growth

In this article, I want to take a little bit of time out to talk about stocks that are fairly valued under the PEG rule but can still provide a good rate of return. A good rate of return to me, would be 12% and above. I don’t really see a margin of safety for any of these five companies that I picked out. Some argue that the margin of safety lies with the quality and competitive strength of the company.

Here are the five companies:

Company Name

Tickers

Landstar Systems (NASDAQ:LSTR)

LSTR

United Health Group (NYSE:UNH)

UNH

Regneron (NASDAQ:REGN)

REGN

Ulta Beauty (NASDAQ:ULTA)

ULTA

Bookings Holding (NASDAQ:BKNG)

BKNG

We are just going to check five criteria to see if these companies have anything that could be revealing in a potentially bad or good way as investments. These five companies all have some sort of excellent/ unique business model that is difficult to imitate. With that being said, let’s go ahead with the first criteria:

Criteria #1: The Earnings Multiple Should Ideally Be Below 20x.

Company

EV/EBIT

LSTR

11.5x

UNH

14.8x

REGN

12.5x

ULTA

22.1x

BKNG

16.3x

Source: Oldschoolvalue

For myself as a general rule of thumb, I don’t like companies that have higher than 20x earnings. There are many variations of valuation multiples to use. We will go with EBIT this time. Each of the five companies show very similar valuation multiples, whether we are using earnings, EBIT or FCF. ULTA here is the only one that has above a 20x EV/EBIT and doesn’t pass this criterion.

Criteria #2: The PEG Ratio needs to be below 1.2x.

PEG Valuation:

Company

EV/EBIT

(EBIT Growth Last 5 Years)

EBIT PEG:

LSTR

11.5x

12.8%

.9x

UNH

14.8x

12.5%

1.2x

REGN

12.5x

27.8%

.45x

ULTA

22.1x

21.3%

1.04x

BKNG

16.3x

17.2%

.95x

Source: Oldschoolvalue

A growth investor needs to look for well, growth. But the biggest mistakes growth investors make are either/both:

1) paying too much for growth

2) misjudging the companies’ prospects

It is for this reason I use the PEG to keep a check on the valuation relative to the growth story I want to pay up for. Even though ULTA is the most expensive on the EV/EBIT basis, it is a pretty decently valued on the PEG basis.

The PEG Ratio has taken many forms and variations, and there are a multitude of variations I have developed over the years. You can refer to my articles here, and here for more references. The one we will be using today will be:

The EBIT PEG Ratio = EV/EBIT ÷ EBIT Growth Rate (Last 5 Years)

Two Additional Points:

1) Check to make sure the EBIT growth rate is relatively consistent.

The company’s growth should be oscillating upwards. Make sure there are no huge one-time earnings. Those don’t count and will boost the growth rate artificially. All five of these companies don’t have one time jumps in earnings.

2) Check to see if the revenue growth rate is keeping up with the operating income.

Some companies that grow through operating leverage will have a higher operating income growth rate than revenue. Just make sure to some degree revenue is growing decently as well. A 30% operating income growth annually and a 5% revenue growth is a red flag and not sustainable. It likely means that the company has little room for reinvestment.

Growth Rate of Each Company Over the Last Five Years:

Company

Revenue Growth Rate

EBIT Growth Rate

LSTR

11.61%

12.8%

UNH

13.06%

12.5%

REGN

26.10%

27.8%

ULTA

20.26%

21.3%

BKNG

16.42%

17.2%

Source: Oldschoolvalue

Excellent! All five companies have revenue growth rates that are nearly identical to the EBIT growth rates.

Criteria #3: The Debt to Equity Ratio Should Be Below .5x

Debt to Equity Ratio:

Company

D/E Ratio

LSTR

.21x

UNH

.71x

REGN

.08x

ULTA

No debt!

BKNG

.98x

Source: Oldschoolvalue

  • UNH and BKNG are pretty highly leveraged so they fail this test.
  • Despite having a 20% growth rate, ULTA has absolutely no debt.

Criteria #4: The Average Return on Invested Capital Should Ideally be 20%+

The Average ROIC From 2014-2018

2014

2015

2016

2017

2018

Avg. ROIC

LSTR

36.03%

36.35%

33.37%

37.70%

44.32%

37.55%

UNH

14.72%

11.95%

13.30%

18.35%

18.22%

15.31%

REGN

17.37%

21.87%

23.03%

22.05%

36.45%

24.15%

ULTA

36.23%

33.02%

36.05%

40.25%

46.40%

38.39%

BKNG

30.60%

21.60%

18.07%

18.05%

39.61%

25.59%

Source: Oldschoolvalue

A company's ROIC is likely what your long-term returns will look like, so give these numbers a long and hard look.

We are using ROIC here, but other return metrics like ROE and CROIC are also good ways to check the company’s profitability.

For some companies like ULTA, who rely a lot on operating leases for their retail stores, some investors like to capitalize the operating leases (basically treat it as a part of invested capital), to get a more “accurate” view on its profitability.

The superstars here are Landstar and Ulta, who have a 37.5% and 38.3% ROIC, respectively, but note that Ulta’s ROIC is trending upwards. That’s an excellent sign and its already a touch higher than Landstar’s ROIC to begin with.

Regeneron and Booking command a pretty respectable ROIC of 24.1% and 25.6% as well.

The laggard, (but not really) here is UnitedHealthCare. But here’s the issue – UNH is an insurance/healthcare company, with their insurance segment comprising 80% of their total revenue. ROE is a more accurate return metric for insurance and bank companies.

This is exactly why you need to understand the business you are in. You need to go beyond the numbers and understand what drives the business fundamentally. Any geeky nerd (me included) can look at the numbers.

So, let’s see what UNH's ROE looks like:

UNH’s ROE from 2014 - 2018:

2014

2015

2016

2017

2018

5 Yr. Avg.

17.31%

17.18%

18.33%

22.10%

23.19%

19.62%

Not bad! A pretty different story - their average five-year ROE is slightly below 20% but their ROE has been showing a steady uptrend. Between the trend and the average, I favor the trend of the company’s profitability. Why? Because businesses ultimately are judged on its performance in the future, not their past. With that being said, UNH is highly leveraged, with a .71x D/E ratio, so the ROE is slightly inflated to a degree. I will still give it a pass since UNH is basically a healthcare insurance monopoly.

Criteria #5: Identify Their Moat and Sustainability (Competitive Advantage)

This is basically a “catch-all” criteria and arguably the toughest one to nail down. Anyone can sit there within seconds and say that the high ROIC translates to a moat and for the most part, it usually does.

But you need to understand why.

Before we are investors, we are business owners. A moat is remedy to a lot of potential risks investors face, including competition, company sustainability, and a reasonable assurance of capital safety (assuming valuation is reasonable).

The second reason this is important: we need to understand the company’s competitive advantage in order to see if the PEG valuation is sustainable. Indeed, the biggest weakness to the PEG rule lies in the quality and sustainability of the growth. If you knew that a company could compound 20% indefinitely, then even a 100x P/E is a steal. We all know that's not realistic. So valuation is always a crucial factor.

Let’s take a look at each one and see what makes them special and sustainable.

#1: Landstar Systems (LSTR)

Landstar Systems

Landstar is a leading transportation services company specializing in trucking logistics.

  • Landstar’s unique business model does not require the company to own any equipment.This model gives the company lower operating leverage than asset-based truckers.
  • Landstar’s vast network of third-party truckload carriers creates a robust value proposition for shippers, particularly during periods of tight supply.
  • Landstar has a variable-cost structure with relatively low capital intensity that helps it generate very high returns on capital.

The last point definitely explains why Landstar has such a high ROIC. Their vast network and their unique “truckless” business model are indeed special. They have 5% market share compared to Hunt JB and XPO Logistics who have 10.27% and a 20.25% market share, so I am inclined to think that there is still a reasonable amount of room to grow.

#2: UnitedHealthCare (UNH)

UnitedHealthCare Group (<a href='https://seekingalpha.com/symbol/UNH' title='UnitedHealth Group Incorporated'>UNH</a>)

Anyone not living under a rock should know who UNH is. They are the largest health insurance in the US, and their insurance network coverage is by far the largest, providing two sources of moat including: a cost and network advantage. Their returns are some of the best in the industry.

In fact, UNH and the major health insurance companies like Aetna, (which are also virtually monopolies) are too successful for their own good. Whenever they leave a certain market, healthcare skyrockets for people because there are so few choices in the consolidated healthcare industry. People basically have to use major healthcare providers. The prices of healthcare have been rapidly increasing but UNH still keeps their customers (and their customer base is still growing!). Their pricing power is terrifying.

Also, the major players in the healthcare industry have been consistently accused of monopolistic practices. Even if you didn’t know a single fly about competitive advantages, just knowing that a company that is always being scrutinized by the government for being a monopoly means this: their competitive advantage is too good.

(It also means they are too successful as a company, ironically).

They still “only” have a 15% marketshare, so, there is still vast growth potential.

#3: Regeneron (REGN)

Regeneron Pharmaceuticals (<a href='https://seekingalpha.com/symbol/REGN' title='Regeneron Pharmaceuticals, Inc.'>REGN</a>) Pharmaceutical companies in general have historically been a very profitable industry. It’s not hard to see why; when you develop a drug, you have a patent to it, and no company can just steal and replicate it. Furthermore, if your product solves a problem in a way competitors and substitutes cannot really replicate, then your product will likely have very strong pricing power. REGN’s Elyea which treats macular degeneration and eye diseases is a good example.

#4: Ulta Beauty (ULTA)

Ulta Beauty (<a href='https://seekingalpha.com/symbol/ULTA' title='Ulta Beauty, Inc.'>ULTA</a>) Ulta benefits from a scale advantage and with so many stores and vast variety of beauty products offered. They have a loyalty program that drives repeat customer and high retention rates. They do very well marketing themselves as an economical way to purchase high grade beauty products.

When something is mainly powered by women, it is virtually an unstoppable beast.

Not only did the cosmetic product industry not decline, sales went UP in the Great Recession! I think funeral home stocks will be the hottest industry to invest in if we start seeing a significant number of husbands mustering up the courage to tell wives that they need to cut back on their make-up spending.

Joking aside, ULTA already has 1,200 stores and though they plan to open an additional 1,700 stores in the future, the market does seem to be getting on the more saturated side for ULTA. In addition, there is no guarantee the future stores will be as good of a fit in other regions.

#5: Booking Holdings (BKNG)

Booking Holdings (<a href='https://seekingalpha.com/symbol/BKNG' title='Booking Holdings Inc.'>BKNG</a>)

Also formerly known as Priceline, they have continued to dominate the online travel industry. They have built a leading network of hotel properties and other services, which drives an increasing user base.

  • In developed markets, replicating Priceline’s leading network in Europe is proving costly for key competitors, as boutique hotels (a substantial portion of the region’s market) that are already signed with Priceline face labor and expense constraints in joining multiple distribution channels.

  • In emerging markets, the firm is expanding its leadership in China with its Ctrip partnership and in its own booking.com and Agoda.com platforms, which is crucial, as we see developing regions representing over half of the total industry online booking growth over the next few years.

They have also been accused of being a monopoly along with Expedia.

Summary & Conclusion:

These are great companies with good growth at reasonable prices. I think that there are better opportunties out there even in today's stock market. REGN is actually pretty undervalued, with a PEG of below .5x.

I summed up the criterias here:

Criteria #1

Criteria #2

Criteria #3

Criteria #4

Criteria #5

EV/EBIT < 20x

PEG < 1.2x

ROIC/ ROE > 20%

D/E Ratio < .5x

Moat Existence

LSTR

Pass

Pass

Pass

Pass

Good

UNH

Pass

Pass

Pass

Fail

Monopoly

REGN

Pass

Pass

Pass

Pass

Good

ULTA

Fail

Pass

Pass

Pass

Good

BKNG

Pass

Pass

Pass

Fail

Monopoly

That wraps up this article. Hope you guys liked it.

My tenth article will be a special one that I have prepared for you guys. It will be the last for the EI series that I have been working on these past few months.

As always, let me know what you guys think about these companies in the comments below, and/or give me a "like". Thanks for reading guys!

Disclosure: I am/we are long UNH, ULTA, REGN, LSTR, BKNG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have a portfolio tracker to see how well these stocks do with a grand stake in each company of about $100 on average. So I am not really "long" on it. I do want to be transparent on it.