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If you're searching for new investment ideas, a great place to start is by looking for companies with high earnings yields and strong returns on invested capital.
Why? Because companies with strong returns on invested capital typically possess solid competitive advantages and demonstrate a knack for creating shareholder value by reinvesting capital in their businesses. When such companies also sport high earnings yields -- meaning they earn a lot for the price we have to pay -- they can potentially represent great opportunities for patient, long-term investors to beat the market.
Before we dig further, though, let's take a quick look at both companies' key metrics next to two of their publicly traded peers:
|Express||Buckle||Gap (NYSE: GPS )||Abercombie & Fitch (NYSE: ANF )|
|Market Capitalization||$1.5 billion||$2.2 billion||$16.5 billion||$3.6 billion|
|P/E Ratio (TTM)||11.0||13.6||15.0||14.5|
|Estimated Forward P/E Ratio||10.2||12.7||12.0||11.2|
|Payout Ratio (TTM)||N.A.||24%||16%||22%|
|Return on Capital||26.74%||42.95%||22.7%||6.3%|
Of course, at first glance and based on the numbers above, there are no glaring problems with Gap or Abercrombie; to the contrary, while Abercrombie's return on capital may leave a bit to be desired, both stocks appear to be reasonably priced with sustainable dividends supported by relatively healthy underlying businesses.
Right off the bat, however, both Express and Buckle look pretty darn cheap based on their trailing price-to-earnings ratios of 11 and 13.6, giving them decent earnings yields of 9.1% and 7.4%, respectively. Coupled with their even more impressive returns on capital of 26.74% and 42.95%, these two stocks start to look downright mouthwatering.
Express, for one, has manageable debt levels based on its relatively healthy debt-to-equity ratio of 0.66 and current ratio of 1.65. Buckle, however, takes the cake here given its sterling balance sheet, which boasted zero debt and total cash and investments of nearly $180 million at the end of its most recent quarter -- and that's even after Buckle forked out $254.6 million in dividends in 2012, including a massive $4.50-per-share special dividend last December.
So why, then, are these stocks so cheap? After all, there has to be some reason investors aren't piling in, right?
An Express ticket to profits
On one hand, while Express met expectations for both revenue and earnings per share with its most recent earnings report two weeks ago, the stock is still reeling after falling margins caused by lower-than-expected foot traffic in February resulted in the company offering cautious guidance for 2013. Of course, in exchange for its prudence, Mr. Market pushed shares of Express down by a whopping 10% that day.
Even so, I agree with the analysts at UBS, who quickly chimed in with a buy rating at the time and placed a $21 price target on Express, noting that its long-term story remains favorable as the company is "taking the right steps to fix the business by simplifying pricing, increasing key items, recognizing fashion trends, and increasing customer prospecting."
What's more, Express' e-commerce sales growth shows no signs of letting up after growing 32% last year. All in all, e-commerce represented more than 12.5% of total sales in 2012, and management expects it to eventually make up more than 15% of the business going forward. In addition, with 625 of its 640 stores currently located in the U.S. and Canada, Express is only just beginning to place greater focus on international expansion through franchises in the Middle East and South America, with plans for existing international franchisees to open an additional 13 to 16 stores this year.
Finally, in the most recent earnings conference call, Express management also discussed an early-stage initiative to develop a new segment of outlet stores, which should afford higher returns on investment than Express' typical locations and could serve as a solid supplement to its already-profitable business model going forward.
Buckle up for long-term gains
Buckle, on the other hand, is a bit more of a mystery considering its shares trade hands at less than 10% below their 52-week-highs set last November. In fact, shares of Buckle are actually up 4% so far in 2013. As I mentioned above, Buckle also has a beautiful balance sheet with no debt and plenty of cash, and the company posted solid quarterly results two weeks ago, meeting revenue expectations and slightly beating estimates for earnings per share.
Unlike Express, however, Buckle managed to tighten its belt and improved year-over-year margins across the board in its last quarter, with gross margin most notably rising 60 basis points from the fourth quarter of 2011 to 48%.
Like Express, Buckle continues to expand its number of locations at a steady pace, and plans to open just 13 new stores in 2013. When all is said and done at year-end, then, that would bring its total store count to 453. Even so, if Buckle can simply maintain its solid margins and continue to grow its cash over time, investors should be able to look forward to years of predictable growth while continuing to collect a solid dividend.
Foolish final thoughts
In the end, I'm convinced Buckle and Express have what it takes to outperform the broader indexes over the long term, so I have no reservations about opening new outperform CAPScalls for both companies.
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