Lessons From 10 Top 10-Year Outperformers

Summary

• In this article, I look at 10 of the best performing stocks over the past 10 years that I knew about 10 years ago, to understand what drove their outperformance.
• For each stock, I compare their total outperformance versus underlying fundamentals and valuation multiples, to see what factors might help spot next decade's winners.
• These mini case-studies are mostly meant to show how top performing stocks can still perform even with high starting multiples, no dividend, or other challenges.
• I do much more than just articles at Long Run Income: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

The record market decline this past Monday, March 9th 2020 marks almost exactly 11 years since the 2009 market bottom. Although many investors may be stressed by this recent volatility and hope to try and guess when and where the new market might be, I wanted to take a step back and see what would have been some of the best performing names I could have bought after that last bottom. To give some benefit to patience, I am looking back only 10 years, so that even if you waited a year after that 2009 bottom, you still would have caught 10 years of stellar outperformance over the S&P 500, even over one of the S&P 500's best decades. What I wanted to identify was whether factors of growth, financial quality, cheap valuation, dividends, or other metrics were most significant in driving the returns of these top-performing stocks. Only the first of these 10 names is among the obvious "FANG" names that have driven much of the US market's recent rise, and so it should give hope to investors who don't like predicting the future or betting on multiple expansion.

For each stock, I will be presenting four things:

1. Relative total return of investing $10,000 in that stock 10 years ago versus in the SPDR S&P 500 ETF Trust (SPY)
2. Growth in underlying fundamentals (sales, profits, cash flows) of the company over the past 10 years.
3. Valuation multiples over time, and what might be a fair multiple to pay for similar quality companies.
4. The bottom line lesson I take away from said company's outperformance.

For this list, I have limited my choices to stocks that I did not buy in 2010, but were already large enough companies at the time that I was familiar with their businesses and could have considered buying the stock. That way I hope it will be most useful for taking away lessons like not being afraid of high P/E ratios. Focusing on stocks that performed much better than ones I actually bought, and seeing what I can learn from them, is what contrasts this article with my earlier one "20 Stocks For 20 Years ... From My 2000 Journal".

Outperformer #1: Netflix

Starting with one of those charts many of us love to hate, the first chart below shows that $10,000 invested in Netflix Inc. (NFLX) 10 years ago would have grown to over $357,000 today. Unlike with SPY, you wouldn't have had to worry about reinvesting or paying taxes on any dividends, since so far NFLX has yet to pay a dividend.

Data by YCharts

The second chart shows what seems to have been the main driver of NFLX shares' stellar stock price outperformance: stellar revenue growth. From sales of just over from $75 million in 2002 to $1.6 billion around 2010, Netflix's revenue has grown more than 12-fold over the past decade to just over $20 billion in 2019. This, on the back of a transition from mailing DVDs it didn't own to the far more scalable and high margin business of streaming proprietary content, might explain why investors have been so patient paying up for a growing business that is far from returning cash to shareholders. Also in the second chart, we see that despite an annual accounting profit approaching $2 billion, Netflix is still net burning more than $2 billion each year in operations, and most of the $4.5 billion/year it has been raising from investors has gone to cover this negative operating cash flow rather than investments. As I've written earlier, I believe Netflix's content and subscriber assets should be enough to cover its current debts, but have doubts on how long the valuation can stay at these lofty levels.

Data by YCharts

Given NFLX's share price performance seems based more on high continued revenue growth, rather than on actual profits, dividends, or buybacks, it is also worth looking at whether there might have been any other clues to have bought NFLX early enough to have caught its outperformance. From 2005 to 2010, YoY revenue growth seems to have remained positive though volatile, swinging from over 40% to below 10%, and there seemed to be plenty of time to pick up some NFLX at less than 2x sales. Since 2010, NFLX's Price/Sales ratio seems to have risen dramatically every time YoY sales growth numbers rise, and the multiple has expanded to its current level of over 8x sales as it has become a mega-cap, growth, momentum stock core to the S&P 500.

Data by YCharts

Lesson from NFLX: I don't think I would have been able to guess how successfully Netflix was later able to crush Blockbuster and become a dominant media streaming brand, and I would have had to have some of that optimism to like NFLX at a P/E of 25-35 in early 2010. I think what is more telling is even if I had perfect foresight into that second chart of NFLX's revenue and cash flows over the next 10 years, I still wouldn't have found the business a good buy. I clearly see NFLX as a growth stock for an investor with a style very different from my own.

Outperformer #2: Lululemon

The second best outperformer on our list is the yoga clothing maker Lululemon Athletica Inc. (LULU). While I understand the proprietary content and scalable subscription model of NFLX, I saw LULU yoga pants as a fancy-branded commodity in 2010, and I still see them as a fancy-branded commodity today. An investor whose $10,000 investment in LULU grew to over $120,000 over the past 10 years clearly saw LULU as the Coca-Cola of yoga pants in ways I still shake my head at rather than appreciating. Note that the vast majority of LULU's outperformance came in just the past 3 years.

Data by YCharts

Where LULU is significantly different than NFLX is in LULU's positive and rising free cash flow. Unlike NFLX, which is still raising cash from investors via bond issues, LULU has been plowing much of its free cash flow into buybacks. Indeed, the past 3 years' outperformance seems to coincide with its second big wave of buybacks.

Data by YCharts

LULU stock has always seemed expensive to me (again, because I failed to appreciate it as the "Coca-Cola of yoga pants"), but the below chart is perhaps the most useful as far as valuation metrics. I usually prefer to buy even good businesses at no more than about 10x EBIT when I can find them, and it seems LULU would have been a great buy anytime it was below 20x. I find it quite interesting that LULU's return on capital line almost looks like a moving average of the EV/EBIT in the below chart, and supports why I might still find it expensive at current levels.

Data by YCharts

Lesson from Lululemon: Don't be afraid to pay a bit more than a usual "expensive multiple" for a business that is clearly very profitable and able to charge a sustained premium. In this case, a valuation multiple falling faster than profitability ratios, paired with a pick up in buybacks, may signal a good time to buy.

Outperformer #3: Mastercard

Mastercard Inc. (MA) was one of those names that I, in hindsight, foolishly avoided for two reasons:

1. It was a "financial", and I was already overweight financial exposure while I was still an employee at banks, and
2. I significantly overestimated the likelihood of Visa (V) and Mastercard becoming obsolete and replaced by technologies like Alipay or Bitcoin within 10 years.

While I certainly understood that MA was not a "financial" in the same way that balance-sheet driven banks were, under-appreciating MA's profitability, scalability, staying power, and asset-light model all cost me the great opportunity charted below. The following chart, on log scale, shows how $10,000 invested in MA would have grown to over $118,000 quite smoothly over the past 10 years.

Data by YCharts

MA's chart of revenues and cash flows show that it is clearly an excellent business, with steadily rising revenues it is able to turn almost half of into free cash flow, and consistently returning most of that free cash flow to investors.

Data by YCharts

As a consistently profitable company, it would be fair to measure MA by a simple P/E ratio, but MA also has one denominator neither NFLX nor LULU have: a dividend. MA has been paying a steadily rising dividend, and seems to be well on its way to becoming a "dividend aristocrat", but has never traded at a yield above 1%. An investor would have had to see the continued future growth and profitability and comfortably accepted that this is a name one rarely gets to buy for less than 25x earnings.

Data by YCharts

Lesson from Mastercard: Although it would have been great to buy MA in 2010, it still would have been a great buy in 2015 even at its then-expensive looking price of over 30x earnings. One would have had to appreciate the strength and staying power of the duopoly of old credit card networks to see this future growth and profitability.

Outperformer #4: Cintas

Coming back from scalable network businesses to clothing, the fourth top performer we will look at here is Cintas Corp. (CTAS), which runs the low-tech business of renting out work uniforms. This boring but perhaps predictable business would have turned $10,000 into just over $117,000 over 10 years, about 4x what SPY would have grown into.

Data by YCharts

Where an investor of my style should have gotten far more comfortable with a name like CTAS is that these fabulous returns did not require much in the way of growth assumptions. CTAS's trailing twelve months sales of just over $7 billion is only about double its top line revenue at the depths of the great recession, and while profits have grown, CTAS is not a high margin business. One significant tailwind, as with LULU, is consistent deployment of those cash profits into buybacks.

Data by YCharts

Looking at how shares have grown faster than sales, one might think CTAS returns were mostly a play on multiple expansion from around 1x sales to 4x sales, but a better and more stable metric for this name is price to free cash flow (P/FCF). CTAS's P/FCF was steadily around 20 from 2010-2015, and has been more steadily around 28 in recent years.

Data by YCharts

Lesson from Cintas: As with LULU, buybacks, and the cash flows to sustain them, seem to be great sign. In CTAS's case, buybacks helped boost return even with far less revenue growth.

Outperformers #5 & 6: Constellation and Monster

In my earlier article, "10 Stocks For 40 Years", I finished with the fact that Coca-Cola (KO) and PepsiCo (PEP) would have turned $10,000 into just over $1,600,000 and $2,000,000 over 40 years respectively, and here was glad to find two other beverage companies at the top of last decade's performers. Here, the two names we look at are Constellation Brands Inc. (STZ) and Monster Beverage Corp. (MNST), which would have turned $10,000 into $112,000 and $97,000 over the past 10 years, respectively.

Data by YCharts

As with other names reviewed so far, steady revenue growth seems like an important leading line of these stocks' outperformance. I was a bit surprised to see that non-alcoholic MNST, which I considered more trendy than timeless, actually has higher and more stable profit margins than STZ.

Data by YCharts

These higher and more stable profit margins help explain why MNST has been trading at roughly double the Price/Sales multiple of STZ. The beverage industry has long been one of my personal favorites, and seeing the below chart makes me quite curious how these two names could have so significantly outperformed industry giants like Coca-Cola and Anheuser-Busch (BUD) given these higher starting multiples, and MNST's lack of dividend.

Data by YCharts

Lesson from Constellation and Monster: As in my 40-year article, it is perhaps not surprising that two beverage companies again appeared as top performers over the past decade, but I would want to learn more about how it was these two. MNST seems to have delivered the higher growth and margins of the two, while STZ seems to have outperformed MNST by being almost as good at "half the price".

Outperformers #7 & 8: Moody's and S&P

As with Mastercard, Moody's Corporation (MCO) and S&P Global Inc. (SPGI) are part of a duopoly / triopoly within the financial sector with a role that is more asset light and profitable than asset heavy banks and insurers. As with Mastercard and Visa, whether you love or hate them, you may find yourself having to use Moody's or S&P's services directly or indirectly, and it will be very difficult for a disruptor to compete with either. In the case of these two giant credit rating agencies, and the latter also an index provider, I was also far too optimistic that the global financial crisis would have challenged their dominance of credit ratings and index benchmarking, and forced a more "open" market for credit rating services. Four years after explaining why I myself don't buy S&P 500 index funds, equity investing has also concentrated into SPGI's "greatest hits" index, rather than becoming modernized and personalized like our music playlists. The below chart shows how surprisingly closely MCO and SPGI stocks have tracked each other over the past 10 years, turning $10,000 into a little more than triple what SPY would have delivered. In other words, the provider of the S&P 500 index, and its main competitor, have both solidly beat the S&P 500 index over the past 10 years.

Data by YCharts

As with Mastercard, both MCO and SPGI show patterns of "wonderful businesses" with steadily rising growth in both revenues and profits that make up a large percentage of those revenues.

Data by YCharts

Neither MCO nor SPGI is an especially high yielding stock, but both have consistently returned more than twice as much to shareholders via buybacks as via dividends.

Data by YCharts

Lesson from Moody's and S&P: Entrenched businesses that some of us may hate paying fees to, but most people don't know or care how much they pay fees to, should not be underestimated as excellent and durable businesses. Again, buybacks serve as a key clue.

Outperformers #9 & 10: Home Depot and Lowe's

The last two outperformers we present in this article are two retailers that should have remained quite out of favor one year after the housing crash: The Home Depot Inc. (HD) and Lowe's Companies Inc. (LOW). HD and LOW turned $10,000 into roughly $89,000 and $51,000 over the past 10 years, as charted below:

Data by YCharts

As with CTAS, neither HD nor LOW managed very high revenue growth rates nor very high margins over the past decade, but both remained consistently profitable, and saw modest margin growth over time.

Data by YCharts

The simple return driver of both HD and LOW, which is easy for many of us to understand, is simple consistent dividend growth available for purchase at reasonable yields. Both have used their profits to raise their dividends 3-5x over the past 10 years. HD has mostly been available at a yield above 2% for most of the decade, while LOW spent most of the past 8 years trading at dividend yields below 2%, despite slower dividend growth.

Data by YCharts

Lesson from Home Depot and Lowe's: Although we had to go this far down the list to find it, for companies not counting on rapid revenue growth, steady profit growth that can support rising dividends at reasonable prices can produce good outcomes.

Conclusion

Of all these examples, Netflix is the only one I would not have bought even with perfect foresight of its future revenues and cash flows, and in fact is the only one of these names where I have put on a short position towards the end of this past decade. In the other cases, it is good to see that top performers of the past decade are not just technology giants, but rather include a variety of businesses able to raise revenues and profits steadily, with some even paying dividends. One significant driver of the returns of many of these companies has clearly been multiple expansion, often from already high-looking multiples, and like momentum, this may be one winning "factor" that might be hard for me to buy into as a traditional "buy low" investor. Perhaps the most encouraging of all these "winning factors / buy signals" has been the use of buybacks, which continues to be one of the top "dividend alternatives" I look for, especially in the US market.

In doing these mini case studies, I hope I have challenged your assumptions about when you screen for in stock purchases as much as these have challenged mine. I have definitely learned to be less dismissive of certain factors that have persisted to drive outperformance of many of these names over the past 10 years, and to look for them in outperformers I look for over the next 10 years.

Analyst’s Disclosure: I am/we are short NFLX. 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.

We are also long NFLX bonds, versus the short position in the stock.

Comments

[brainleft]

pool, under the radar steady Eddie

[btw3006]

Great article. Definitely gonna keep this one in my "back pocket"

[The Abstract Investor]

Great article!

[dieuwer]

Great article. If $NFLX ever gets below PS = 3, it will be a strong buy IMHO.

[Varan]

You forgot the rarely mentioned TPL. 1793% return since 3/11/2010.

[Tariq Dennison]

I didn't know about TPL back in 2010, and it was well below $1bio back then = two reasons I didn't include it this time.