Would Jeremy Grantham Buy Lam Research?

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. He 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 / P > 4%
10-year Treasuries are yielding about 3%. We want more return than that.

With the definitions out of the way, let's see if Lam Research (Nasdaq: LRCX  ) can pass our sniff test.

As you can see from the table below, Lam Research has a positive net cash position on its balance sheet. What's more, the company currently 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

Lam Research Corp.

$808.8

28.6%

5.9%

KLA-Tencor Corp. (Nasdaq: KLAC  )

$788.3

12.8%

7.5%

Kulicke & Soffa Industries Inc. (Nasdaq: KLIC  )

$66.0

N/A

2.7%

Source: Capital IQ (a division of Standard & Poor's) and author calculations.
Dollars in millions.

How does it stack up to the competition? Competitors KLA-Tencor and Kulicke & Soffa don't quite make the grade on this test. Both KLA-Tencor and Kulicke & Soffa have more cash than debt on their balance sheets, which is a good thing. Where they both miss is on the ROIC side, with KLA-Tencor's too low and Kulicke & Soffa recently turning in a loss.

Foolish conclusion
Would Jeremy Grantham buy Lam Research? 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 Lam Research a good, hard look. And you and I should, too.

Million Dollar Portfolio associate advisor David Meier does not own shares of any of the companies mentioned. The Motley Fool has a healthy disclosure policy.


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