The long-term outperformance of individual stocks in the stock market is my main objective. That’s what I’m looking for in this piece.
I recently wrote the article “Stocks to Buy and Hold Forever”.
She shared the same objective: to find actions that perform better than others due to consistent growth, buybacks and dividend increases. I also look at the current valuation because even the best stocks are overvalued.
The idea is simple: find stocks with a strong history, perpetual revenue and earnings growth, and consistent returns for shareholders. These types of stocks tend to outperform the market over the long term.
Buying and keeping should not be taken at face value.
The company must adapt as new trends arrive. Otherwise, selling and looking for a better investment may be preferable.
An investor should keep an eye on a company’s valuation. Even the best company can become an expensive stock with little upside potential.
It is also possible to reduce positions over time, as you need cash as income.
I selected these 10 actions previously:
- Alphabet (GOOG, GOOGL)
- Apple (AAPL)
- ASML (ASML)
- Best Buy Co (BBY)
- Black Rock (BLK)
- Costco Wholesale Corporation (COST)
- Home Depot
- Mastercard Incorporated (MA)
- Microsoft Corporation (MSFT)
- Pooling company (POOL)
I kept the same method as last time.
These are my selection criteria of what I consider to buy and hold forever stocks.
- The first is subjective. I’m looking for a strong story behind the company. A solid strategy and clear objectives make the investment case more attractive.
- Strong growth in revenue per share and good profitability are essential.
- A high return on equity proves management efficiency.
- Redemptions and dividends are signs of shareholder-friendly management. All listed companies have regularly returned cash to the market through buybacks, dividends and often both.
- The solid past performance of the stock market measured in total return contributes to support the previous points. It is not an indication of the future, but underlines the appreciation of the company by the market, especially if the valuation has not changed too much.
Selection with common characteristics
I picked three stocks that I think are undervalued by the market:
- BJ’s Wholesale Club Holdings, Inc. (BJ)
- Tractor Supply Company (TSCO)
- Ulta Beauty, Inc. (ULTA)
Before delving into these individual actions, I want to highlight the common ground.
High return on equity
All three companies operate with a high ROE. Return on equity measures the efficiency with which management converts equity into net earnings.
It is a tool for measuring a management team’s capital allocation decisions and its ability to increase shareholder value. This says nothing about the company’s current valuation.
All three companies have posted excellent ROE ratios in the past.
I talked about finding a strong story behind the business. I want to confirm this story with its past and expected revenue growth.
Investing is not about the past, but the past gives confidence in the company and the management. History does not repeat itself but often rhymes.
Past figures are good for all three companies. Analysts’ forward earnings estimates also look positive for this year. I think these three companies could maintain a high growth rate for a long time with their strategies.
Excellent past performance
For the first article, I looked specifically at companies with longer public histories that have outperformed the S&P 500 (SPY).
These three stocks have outperformed the S&P 500 since they operate as public companies.
BJ’s story is short and not yet a sign of long-term outperformance. The others show excellent long-term appreciation.
These increased stock prices should not be confused with expensive stocks. The current stock price is irrelevant to a company’s intrinsic value. A company is valued with ratios or other valuation models.
Positive free cash flow and shareholder returns
Free cash flow is vital because it is what a company could use for shareholder returns. Potential buyouts or dividends are only possible if the company generates sufficient cash.
These three companies generate consistent positive free cash flow.
They use all redemptions for returns to shareholders. Only TSCO pays an increasing dividend. The regularity of returns to shareholders is a sign of management that respects shareholders.
BJ’s Wholesale Club Holdings
BJ’s is a warehouse club with low prices similar to Costco or Sam’s Club. It provides value to its members who pay an annual fee. The membership fee is a critical source of revenue as it turns almost entirely into revenue and free cash flow. The design behind these clubs is simple and attractive.
BJ increases the number of clubs he operates, his revenue and buying power, gets better deals for his members, and attracts more members per club. This creates a flywheel effect.
It plans to increase its number of locations by 4-5% per year in the future. Together with comparable store sales and membership growth by club, this should translate to annual revenue growth of approximately 7-8%.
FCF and returns to shareholders
Free cash flow is lumpy because it often stores inventory for later quarters. This always corresponds to earnings. It has primarily used its free cash flow (“FCF”) to pay down debt over the past two years.
BJ’s does not pay a dividend and does not anticipate a dividend soon. It has been public since 2018 and has only used share buybacks to return money to shareholders.
It has $413 million left in its current buyout program. The redemption yield is likely to remain relatively low as the company invests in growth.
BJ’s rating metrics are in line with his historical averages. The EV in FCF is distorted due to its cash cycle and is expected to normalize over the next few quarters. Its flawless performance makes the company a buy at the current valuation.
Please read my last article on BJs for further research.
Tractor Supply Company
The company is a rural lifestyle retailer in the United States. It sells various products to recreational farmers, ranchers and others. It operates in a niche that is experiencing secular growth. The trend of people wanting to live a rural way of life works in its favor. It is the US market leader in its niche. The rural way of life has proven to be recession proof in the past.
Tractor Supply Co continues to expand the number of stores at a steady pace. It plans to open 70-80 Tractor Supply stores and 10 Petsense stores in 2022. It expects to maintain that 4% growth rate through 2026. Acquisitions could open up new avenues of growth.
FCF and returns to shareholders
Free cash flow tends to fluctuate as inventory goes up and down. I expect the FCF to rise again in the next couple of quarters. TSCO uses its FCF for buybacks and a growing dividend.
Buyouts hit a record high as TSCO pledged to return cash to shareholders. It has $1.9 billion left under the current share buyback program.
The quarterly dividend increased by 77% at the start of the year. Further dividend increases are likely as its payout ratio is 38% and earnings are expected to grow in double digits. The forward dividend yield is now 1.9%.
TSCO looks reasonably priced, with a P/E well below its historical average. EV to FCF is well above average due to increased inventory.
Ulta is another niche US retailer. It offers a wide range of beauty products. It operates 1,325 stores with expansion possibilities for 1,500 to 1,700 stores.
The beauty industry is holding firm against other retailers due to the relatively low cost. It’s affordable splurge for a lot of people.
Ulta is targeting net sales growth of 5% to 7% CAGR by 2024. The latest results suggest that this outlook was too conservative, as the company is growing around 10% in 2022. In the past, the Store openings have been happening at a decent pace, increasing the number of locations. from 3.5% to 4% per year. It plans 50 additional stores in 2022, an increase of 3.8%. It is also opening locations at Target (TGT) stores.
FCF and returns to shareholders
Ulta has increased its FCF conversion as it has grown. It achieves excellent figures while increasing its income. Net income and free cash flow have been roughly in sync over the past two years.
Ulta is aggressively buying back stock with its free cash flow. The current program still has $1.6 billion in firepower. It does not pay a dividend.
Ulta has a very reasonable value. This is well below its historical average. Part of the discount makes sense because the growth rate going forward will be slower than in the past. An AP/E of around 20 is reasonable for a stock with proven management and double-digit EPS growth.
Long-term outperformance is my main investment objective. I believe these stocks could become such winners because they are proven and reasonably valued.
I focused on stocks with developing locations in the United States. Greater diversification across sectors is desirable to create a strong long-term portfolio.
Tractor Supply Company was a suggestion in the comments to the previous post. I look forward to reading your ideas below!