Never forget the basics.
While we’re constantly bombarded with confusing investment mumbo jumbo, we should never forget that companies largely exist for one main reason: to take capital from investors and earn a return on it.
That’s why it makes sense for investors to look for businesses, with durable competitive advantages, that are able to consistently deliver high returns on capital.
As Berkshire Hathaway CEO Warren Buffett once said, “[T]he best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.”
With that in mind, here are three companies with returns on invested capital above 15%.
Home Depot
Kicking things off is Home Depot, which consistently generates returns on invested capital around 30%.
Thanks to the home improvement giant’s massive economies of scale, well-recognized brand, and concise merchandising, management has been able to produce above-average operating metrics while rewarding shareholders in the process.
Over the past five years, the company has returned more than $55 billion to shareholders in the form of dividends and share repurchases.
While growth has been a bit disappointing of late — customer transactions dropped 5.8% in the most recent quarter — the long-term trend of investing in the home should continue to work in Home Depot’s favor
With a total yield of 3.8% — 2% dividend yield and 1.9% buyback yield — the stock’s risk/return tradeoff looks attractive enough to act on.
Apple
Next up, we have consumer technology gorilla Apple, which boasts a five-year return on invested capital of 26%, much higher than that of rivals like Nokia (12%) and Sony (7%).
Even in the cutthroat world of consumer hardware, the iPhone maker has been able to generate outsized returns due to its loyalty-commanding brand and high switching costs (the iOS experience can only be had through Apple products).
And with the company continuing to penetrate emerging markets like India and Mexico, Apple’s long-term growth trajectory remains healthy.
In the most recent quarter, Apple’s revenue jumped 36% to $81.4 billion. The company also generated a whopping $21 billion in operating cash flow and returned about $29 billion to shareholders.
The stock currently sports a dividend yield of just 0.6%, but with a buyback yield of 3.2%, Apple is doling out more cash to shareholders than you might think.
Microsoft
With a solid five-year return on invested capital average of 20%, software giant Microsoft rounds out our list.
While many consider Microsoft to be a slow and stodgy tech play these days, the company’s still-monopoly-like position with Windows and Office, coupled with an expanding presence in the fast-growing public cloud space, gives the stock a solid risk/reward tradeoff.
For the June quarter, net income jumped 47% to $16.5 billion as revenue increased 21% to $46.2 billion. The company’s Intelligent Cloud segment increased 35% to $3.9 billion driven largely by strong demand for its key cloud computing service Azure.
More importantly, gross margin expanded 25% during the quarter, suggesting that Microsoft’s competitive position is only getting stronger.
Currently, Microsoft shares offer a dividend yield of 0.7% and a buyback yield of 1.1%. The stock has traded sluggishly over the past week, providing contratrian investors with a possible entry point.
A different high-return path
Even if you don’t like these specific stock picks, you should still look to implement Buffett’s time-tested strategy of investing in stable, high-return assets at discounted prices.
One steady asset that Buffett’s good friend Bill Gates is partial to is investing in U.S. farmland.
In fact, Gates is America’s biggest owner of farmland and for good reason: Over the years, agriculture has been shown to offer higher risk-adjusted returns than both stocks and real estate.
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
