Some investors try to time the market. When it comes to quality stocks backed by wonderful businesses, the best time to buy them is in the past. The second best time to buy them may be now.
Here are two interesting metrics investors can observe in top-notch stocks: retained earnings and high returns on invested capital (ROIC).
What do retained earnings tell you?
On a company’s balance sheet, in the shareholders’ equity section, you can find a company’s retained earnings. Having retained earnings implies that the company has earnings left over after paying for costs, income taxes, and dividends to shareholders. It means the company has been profitable through the long-term operation of the business. The opposite of retained earnings is accumulated deficit, which means that since the company has been in operation, it has experienced more losses than profits.
Of course, for the more recent earnings power of the company, investors can look at the net income or earnings per share (EPS) of the company. For example, you can compare a company’s year-to-date EPS versus the same period in the prior year. Generally, investors want to see a growing trend of earnings, but cyclical businesses will naturally have cyclical earnings.
For example, Constellation Software (TSX:CSU) last reported retained earnings of close to US$1.55 billion, while Alimentation Couche-Tard (TSX:ATD) last reported retained earnings of $13.4 billion. It would be reassuring to see a treasure chest of retained earnings in a company.
What’s special about the return on invested capital?
The higher the return on invested capital, the more efficient a company is in allocating capital in profitable investments. So, generally, investors want to see high ROIC in a company. A business is super valuable if it can consistently maintain a high ROIC through the economic cycle.
For example, according to Morningstar, the five-year ROIC of Constellation Software and Alimentation Couche-Tard are approximately 25.2% and 13.8%, respectively. That said, Constellation Software’s ROIC has been declining in the past five years from about 36% to 18%, whereas Alimentation Couche-Tard’s ROIC has increased from about 13% to 15%.
The power of growing earnings
Rising earnings per share lead to a higher stock price over time. In the past 10 years, Constellation Software increased its adjusted EPS by 23.3%, which helped drive the stock price about 1,400% higher with the help of valuation expansion. Specifically, the stock’s price-to-earnings ratio expanded from about 18 times to north of 35 times.
In the past 10 fiscal years, Alimentation Couche-Tard increased its adjusted EPS by 22.5%, which helped drive the stock price about 542% higher with little help from valuation expansion. Specifically, the stock’s price-to-earnings ratio expanded from about 16.8 times to north 17 times only.
Although Couche-Tard’s earnings growth isn’t expected to be as impressive as Constellation Software’s, Couche-Tard trades at a much more acceptable valuation. Additionally, Couche-Tard is shareholder-friendly with a growing dividend, which 10 times in the last decade. This means that if you earned $1,000 in annual dividends from the stock 10 years ago, you would now earn $10,000 from the same investment.
If you have an extra $1,000 to invest, Constellation Software and Alimentation Couche-Tard are some of the best TSX stocks to buy.
