Step 1: Screening
We begin by charting Enterprise Value / Invested Capital vs. Return on Invested Capital for the entire universe:
- Stocks residing below the regression line are candidates for further evaluation
- Stocks above the line are considered overvalued
Step 2: Quantitative Analysis
We rate the stocks in our universe according to our proprietary quality rankings model using the following factors:
Step 3: Qualitative Review
We believe quality companies defend and maintain high returns on capital through proven/durable competitive advantages, such as:
Step 4: Valuation Test
We understand that a company’s market value is comprised of its invested capital and discounted future economic profits:
- Therefore, a company only creates value if its return on invested capital (ROIC) is greater than its cost of capital (COC)
- And, if the ROIC is less than its COC the company destroys capital and market value should be less than invested capital (these are stocks we look to avoid)
