When Jeremy Grantham speaks, I listen. He's not afraid to have a contrarian mind-set lead him in a different direction from the crowd. Recently, Grantham believed some high-quality companies traded at attractive prices. Grantham wasn't sure why the high-quality names were on sale, but he thought they offered the best returns for the next seven years. He has a pretty good long-term track record of sniffing out where the best returns are, so let's see what companies Grantham is rooting out.
What do "high-quality" and "on sale" mean? Certainly they will represent different things to different people. For our purposes, let's say high-quality companies have a strong balance sheet and generate excellent returns on invested capital. We'll use free cash flow yield (free cash flow / market cap) compared to the 10-year Treasury yield as a proxy for value.
So a Grantham-like opportunity would have:
1. Net cash position > 0
More cash than debt can indicate a strong balance sheet.
2. ROIC > 15%
Earning a 15% return should be more than a company's cost of capital.
3. FCF / Price > 4%
Ten-year treasuries are yielding about 3%. We want more return than that.
With the definitions out of the way, let's see if medical technology company Masimo
As you can see from the table below, Masimo has a positive net cash position on its balance sheet. What's more, the company earns a return on invested capital that is higher than its cost of capital. Fools love companies that take shareholder capital and create value with it.
|
Company |
Net Cash (in millions) |
ROIC |
FCF/P |
|---|---|---|---|
|
Masimo |
110.8 |
37.2% |
4.8% |
|
Edwards Lifesciences |
142.8 |
16.9% |
2.3% |
|
Covidien |
-838.0 |
8.2% |
8.7% |
How does it stack up to the competition? Masimo has the best combination of factors. Edwards Lifesciences has a net cash position on its balance sheet and earns an attractive ROIC, but doesn't offer an attractive yield. Covidien, on the other hand, is lacking in both areas, with more debt than cash and a lower ROIC.
Foolish conclusion
Would Jeremy Grantham buy Masimo? That's really hard to say. After all, he's his own investor. But with quality numbers like the ones above, I have to believe Grantham would certainly give Masimo a good, hard look. And you and I should, too.
