The Best Businesses to Own

When Warren Buffett speaks, we Fools love to listen. After all, with so many stock-picking systems out there, it's useful to know what the Oracle himself looks for in a purchase.

For example, in the 1992 Berkshire Hathaway annual report, Buffett shared this extra-golden nugget of investment wisdom: "The best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return." Simple, right?

In today's fast-paced, info-overloaded world of finance, it's easy for investors to forget that companies exist for one basic purpose: to take money from investors and earn a return on it. It only makes sense, then, to focus our stock search on the best businesses, the ones that generate the highest rates of return.  

Return on CAPS
With the help of our Motley Fool CAPS community, I'll attempt to unearth Foolishly loved companies that consistently compound wealth at exceptional clips. In addition to boasting trailing-three-year average returns on capital (ROC) above 20%, these stocks have received perfect five-star ratings in our database:

So, without further ado:

Company

Return on Capital
(3-Year Average)

Industry

Foster Wheeler (Nasdaq: FWLT  )

100%

Heavy Construction

Quality Systems (Nasdaq: QSII  )

36%

Health-Care Services

Marvel Entertainment (NYSE: MVL  )

32%

Movie Production

Colgate-Palmolive (NYSE: CL  )

32%

Personal Products

Gilead Sciences (Nasdaq: GILD  )

31%

Biotechnology

FactSet Research Systems (NYSE: FDS  )

25%

Information & Delivery Services

GrafTech International (NYSE: GTI  )

22%

Industrial Electrical Equipment

Data from Capital IQ, a division of Standard & Poor's, and Motley Fool CAPS.

Of course, don't hurry out and buy these stocks just yet. You'll need to apply some Foolish due diligence of your own, considering things like valuation, quality of management, and whether its competitive advantages are durable enough to continue posting remarkable returns.

With all that said, FactSet Research Systems is a good place to start.

Get your FactSet straight
The only way a company can generate outsized returns reliably for a prolonged period is by owning a sustainable economic advantage. When you couple FactSet's long history of 25%-ish returns on capital with its six-month streak as a five-star stock, I'd say that's a good indicator of a yummy business model. All 106 CAPS All-Stars who've rated the financial information provider like it to outperform, primarily due to the economic moat it has built for itself.

FactSet combines more than 200 databases from multiple sources into a single online source, and provides the information to analysts, investment banks, and other investment professionals globally. It isn't much of a stretch, then, to understand exactly how FactSet derives its edge: high switching costs.

Take a peak at FactSet's CAPS page, and you'll find bullish comments about the company's extensive databases, range of functionalities, and high compatibility with Microsoft Office applications. Naturally, all of those points suggest that FactSet's services are a deeply entrenched part of clients' routines, which is exactly what the numbers bear out. The company boasts client-retention rates above 95%, while its annual subscription value continues to grow at a 20% pace. 

Of course, you might be wondering how FactSet has fared lately. Even amid the financial turmoil, FactSet managed to post third-quarter revenue and profit growth of 22% and 14%, respectively, pointing to the diversified nature (both globally and by business segment) of its client base. So, when you consider how FactSet's "moat" has protected profits over the years, and especially how it holds up in today's tumultuous environment, it's reasonable to think the trend of high ROC will only continue.

Now, let's hear directly from our CAPS community. Two months ago, CAPS player richardrogers4 added a fact set of his own: 

  • Majority of customer base is composed of buy-side firms in the financial sector which gives it a more stable revenue base.
  • Growing international business
  • Annual retention rate of 95%
  • Impressive financials -- great ROE / high margins.

The best is yet to come
Businesses that invest in products and services at high rates of return are simply the best kind of investment. By screening for stocks that have a track record of strong returns on capital, you'll be one step closer to adding that life-changing, wealth-compounding machine to your portfolio.

To gain a better feel for the ideas mentioned above, or to pan for even more highly rated, high-return businesses, join Motley Fool CAPS today. It's absolutely free -- one of the most attractive returns on capital you'll find anywhere.

Quality Systems and Marvel are Motley Fool Stock Advisor recommendations. Colgate-Palmolive is an Inside Value pick. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Brian Pacampara owns no position in any companies mentioned. The Fool's disclosure policy is never bested.


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