When I began investing, I started from a knowledge base of zero.
One of the first books I read when I got started was The Motley Fool's Rule Breakers, Rule Makers. In it, Motley Fool co-founder Tom Gardner laid out specific criteria for crowning a company a "Rule Maker," i.e., a large, mature, consumer-facing company that's king of its market space, and an investment that can be confidently and profitably held onto for years with only quarterly check-ins.
His step-by-step process for analyzing a business was an easily understandable way for a beginner like me to quickly get up to speed, but the back-to-basics methodology will benefit even advanced investors. Today we're going to run Unilever (NYSE: UL ) through Tom's merciless gauntlet and see whether it has what it takes to make the Rule-Maker grade.
1. The mass-market, repeat purchase of low-priced goods
Unilever is a U.K.-based consumer-goods giant. And while the name of the parent company may not ring an immediate bell, its many wholly owned brands will, including Dove, Pond's, Vaseline, Slim Fast, and Hellman's, just to name a few.
And according to Unilever, 160 million people around the globe choose a Unilever product every day. That's a lot of choosing. As such, Unilever easily makes our first Rule-Maker grade.
2. Gross margin
Gross margin is an indicator of manufacturing efficiency, brand power, and pricing power. Unilever's trailing-12-month gross margin is 40%, easily beating the industry average of 25%. Rival Procter & Gamble (NYSE: PG ) manages to do significantly better on this metric, coming in at 49%.
Colgate-Palmolive (NYSE: CL ) excels here, with a TTM gross margin of 57%, while Clorox (NYSE: CLX ) and Church & Dwight (NYSE: CHD ) come in at a respectable 42% and 44%, respectively.
3. Net-profit margin
Net-profit margin dictates how many pennies a company gets to keep from every dollar of sales. Tom Gardner likes to see net-profit margins of around 10% for his Rule Makers.
- At 9.15% TTM, Unilever is right in the pocket.
- P&G comes in a bit higher, at 11.29% TTM.
- Colgate-Palmolive is even better, at 14.45% TTM.
- Clorox is strong at 9.91% TTM.
- And C&D is very healthy, at 11.5% TTM.
4. Sales growth
Year-over-year sales, or revenue, growth counts even for big companies, where it will naturally slow with age, because it's an indicator of business momentum. Top-tier rule makers grow their sales by 10% every year.
- At 9.4% YOY, quarterly growth for Unilever is strong.
- At 1.5% YOY, quarterly growth for P&G is weak.
- Colgate-Palmolive is exhibiting decent quarterly growth, at 5.2% YOY.
- Clorox is better than decent, at 7.4% YOY quarterly growth.
- Finally, C&D fares about as well as Clorox, at 7.5% YOY quarterly growth.
5. Cash-to-debt ratio
Rule Makers should be cash-heavy and debt-light, ideally having at least 1.5 times as much cash on the balance sheet as debt.
- With $5.04 billion in cash and $17.25 billion in debt, Unilever's C/D is an unenviable 0.29.
- With $3.99 billion in cash and $33.11 billion in debt, P&G's C/D is an even more unenviable 0.12.
- With $1.13 billion in cash and $4.97 billion in debt, Colgate-Palmolive's C/D is about the same at 0.23.
- With $303 million in cash and $2.85 billion in debt, Clorox's C/D is the worst yet, at 0.10.
- With $232 million in cash and $249 million in debt, C&D's C/D is still only 0.93.
However, we need to keep this in a bit of perspective. Big debt is the name of the game in this industry; it's vital to growing to a scale that makes the economics more profitable, and none of these companies should have a hard time meeting their interest payments.
6. The Foolish Flow Ratio
The Foolish Flow Ratio measures how well a company manages its inventory and cash. Specifically, a company should be keeping its inventory and accounts receivable low and its accounts payable high--strong indicators of market-space dominance.
To calculate the Foolish Flow Ratio, take current assets minus cash, cash equivalents, and short-term investments, and then divide by current liabilities. The best companies have Foolish flow ratios of 1.0 or less, with 1.25 being acceptable. As of the most recent quarter:
- Unilever's F/F is an enviable 0.75.
- P&G's F/F is an also enviable 0.71.
- Colgate-Palmolive's F/F is a solid 0.94.
- Clorox's F/F is a very lean 0.53.
- C&D's F/F is a not-so-lean but not terrible 1.3.
7. Your familiarity and interest
What's in a name? A lot. Your familiarity and interest with a company help you understand exactly what it does and how it makes money, thereby lowering your overall investing risk.
The name Unilever may not roll off your tongue every day, but many of the company's brand names do, and that's precisely the kind of name recognition that really counts for these big, multinational consumer-goods companies. As such, Unilever scores well on this Rule-Maker metric.
Three cheers for Rule Maker Unilever!
All of our companies are doing a good job managing their assets and liabilities. Unilever's gross margin could be better, but the company has the best YOY revenue growth. And if its profit margin isn't top of the list, it's still solid by Rule-Maker standards, and that's what matters here.
As older, more established companies, Rule Makers don't have to hit every number out of the park. Their beauty lies in their longevity and their ability to steadily generate revenue and profit quarter after quarter, year after year. And that's Unilever.
In Rule Breakers, Rule Makers, Tom Gardner goes into even greater depth and detail about what exactly makes a Rule Maker a Rule Maker. So I suggest you pick up a copy for yourself and get the whole story from the man who, literally, wrote the book on it.
Of course, Unilever isn't the only easy-to-understand stock you can profitably and confidently hold onto for the long term. Learn about the stock The Motley Fool is calling its top pick for 2012 in this special free report: "The Motley Fool's Top Stock for 2012." Get it while the stock is hot.