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 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 Vascular Solutions (Nasdaq: VASC ) can pass our sniff test.
As you can see from the table below, Vascular Solutions 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
|
ROIC
|
FCF/P
|
|
Vascular Solutions
|
$18.2
|
17.5%
|
5.9%
|
|
St. Jude Medical (NYSE: STJ )
|
($1,294.8)
|
16.8%
|
5.0%
|
|
Abbott Laboratories (NYSE: ABT )
|
($14,096.3)
|
14.4%
|
9.0%
|
Source: Capital IQ, a division of Standard & Poor's, and author calculations. Dollars in millions.
How does it stack up to the competition? Vascular Solutions has the best combination of factors. St. Jude Medical and Abbott Labs both have more debt than cash on their balance sheets. In this exercise, those don't make the grade.
Foolish conclusion
Would Jeremy Grantham buy Vascular Solutions? 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 it a good, hard look. And you and I should, too.
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