What happens if you find a company with a good track record of earnings growth, but you think it is too late to invest? In some cases, a company’s ability to consistently grow their earnings over time proves to be more important than when an investors chooses to buy.
This is because the compounding effect of growing earnings can often outweigh the merits of trying to ‘finesse’ a desired valuation.
With this in mind, Trustnet asked four fund managers who take a quality-growth approach to pick one stock that has been so successful at compounding its earnings that the entry point hasn’t really mattered.
Ian Mortimer, manager of the $759m (£548m) Guinness Global Innovators fund, picked Roper Technologies as an example.
“Roper has generally traded on a 30% to 40% premium to the S&P 500 in terms of its price-to-earnings multiple over the past 10 years, yet has outperformed the benchmark by more than 200% over that period,” he said.
“The company has a successful and long history of exceptional capital allocation, especially in M&A [mergers and acquisitions], with a focus on leaders in niche markets with high switching costs that fit into Roper’s ‘cash return on investment’ principle of high recurring revenues, asset-light business models, and accretive free cash flow generation.”
Roper Technologies develops software and engineered products for niche end-markets such as smart water meters, radiotherapy products, pumps and pressure sensors, as well as logistics networks and application software.
Performance of Roper Technologies over the past 5 years
Source: Google Finance
Mortimer said that as the company has developed from being an industrial company to one that also includes software, its margins have steadily improved.
“Combined with good revenue growth and continued operational efficiency, this has led to significantly increased returns on capital despite a growing asset base,” he said. “Economic profit growth has therefore accelerated year-on-year.”
Going forward, Mortimer is still bullish on the company because of its leading position within its end-markets, its “tried-and-tested” approach to growth opportunities, and the fact that its valuation may not be fully reflecting the value of its software business.
Tom Record, co-manager of the Majedie Global Equity fund, picked MercadoLibre – the Latin American e-commerce and fintech business, as an example.
He said: “The stock has been volatile but has consistently grown its revenues and earnings potential – so much so that it doesn’t matter when you bought it.
“In 2013 the company generated revenues of $473m, and in the past 12 months revenues hit $5.5bn, a compound annual growth rate of 39%, or an 11x increase over seven and a half years.
“Similar to Amazon in its early years, the company prefers to invest for growth and minimise profits rather than hold back on growth and generate fatter margins.”
Performance of MercadoLibre over the past 5 years
Source: Google Finance
However, MercadoLibre’s share price growth hasn’t been as consistent as its earnings growth. The spectacular returns over the period have “masked some equally spectacular drawdowns”, as the shares have fallen more than 35% four times since Record first bought them in 2014.
“This illustrates the importance of patient and long-term investing,” Record said. “We focus on what a business might be worth in five years’ time and so view short-term weakness as an opportunity rather than a problem.”
Looking ahead, the manager thinks MercadoLibre still has room to grow due to its long-term perspective, coupled with its opportunity in both e-commerce and fintech.
“In a market that is beset by frequent crashes and crises, MercadoLibre stands out for its long-term perspective,” Record said. “Founder Marcos Galperin has built a business to grow across decades, rather than one to sell before the next (usually quite frequent!) crisis hits.”
Gavin Harvie, co-manager of the £214m Heriot Global fund, picked Thermo Fisher Scientific as his example of a company where the entry point hasn’t really mattered.
“Imagine the world’s most sophisticated biotech lab, one that is constantly evolving, seeking the answers to life’s big questions,” he said.
“Thermo Fisher develops and manufactures products and services to help that lab make ground-breaking discoveries as efficiently as possible, year after year. It operates in a highly fragmented industry worth $165bn, growing 5% per year.”
He highlighted the company’s share price growth of 26% per year over the past decade and 30% per annum over the past five years.
Performance of Thermo Fisher Scientific over the past 5 years
Source: Google Finance
“While Thermo Fisher currently trades on a 23.5x price to cash flow versus a ten-year average of 17.5x, long-term investors should be well rewarded with a 1.2% yield (dividends and repurchases) and strong dividend growth,” Harvie said.
The company has grown to become one of the largest pharmaceutical contract development and manufacturing businesses in the world, with expertise in vaccines and biologic therapies.
“Thermo Fisher may enter decade long relationships with customers due to capital requirements and high regulatory hurdles,” Harvie said.
“These quality cash flows are reinvested in innovation to accelerate growth which can be observed in trend growth rising from 4% per annum to over 6% per annum through the past five years.”
Any decline in valuation would therefore represent an attractive entry point, he argued, adding that factors such as demographics, innovation, and emerging markets could lift this further.
Laure Negiar, manager of the $1.3bn Comgest Growth World fund, picked Intuit – the American financial tax and preparation software company for small and medium-sized businesses.
“Intuit has compounded earnings at a 22% annual growth rate over the past four fiscal years,” she said. “The majority of that growth has come from top-line [revenue] growth, which compounded at a 17% annual rate over that time.
“This notable and consistent top-line growth came from a number of drivers including market share gains, and an expansion of the company’s addressable market which was enabled by a move to the cloud.”
Performance of Intuit over the past 5 years
Source: Google Finance
“Going forward, we believe the company will compound its earnings at annual rate of 15% or above, with the help of the same growth drivers,” Negiar added.
She noted that the recent acquisition of Credit Karma would increase the firm’s revenue streams, while it has also invested in technology, making it harder for new competitors to enter the market.