When we think about high-return stocks, we often think of businesses that solve a complex problem by curing diseases or creating the next social network. But some of the market's best performers are actually found in relatively sleepy industries like retail, consumer staples, and restaurants -- generating market-beating returns by simply delivering a better product than their peers at a fair price.
Home Depot turned $5,000 into $42,252
There is nothing exciting about Home Depot. It's a home improvement retailer that sells everything from toilet bowls to paint. Little has changed at the company. Its store count has grown only about 29% in the past 15 years, but sales have grown by 73%, thanks to a combination of inflation and increased volume per store.
Home Depot is lucky to compete in a market where its strongest competitor Lowe's isn't particularly aggressive in competing on price. Both companies generate roughly the same gross margin as they buy products for about $0.66 and sell them for $1.00. It's a simple business, but done well, it can lead to extraordinary outcomes.
Retail is a business unlike most others. Retailers' expenses are generally fixed, so the costs of doing business typically grow at a slower pace than sales. In fiscal 2009, when sales and profit were depressed by the recession, operating margin stood at 6.1%. In 2017, operating margin expanded to 14.5%. Retailers win twice from rising sales as both volume and margin increase, driving outsize profit growth.
Home Depot compounded on its success by sending a lot of capital back to shareholders in the form of dividend payments and stock buybacks -- the number of shares outstanding was nearly cut in half in the past 15 years. The net result is a perfect storm for investors: rising sales, widening margin, fattening dividends, and a shrinking share count. That's a very simple recipe for market-beating returns.
A bet on baking soda turned $5,000 into $55,391
Church & Dwight's best-known brand is Arm & Hammer, a trademark that dates all the way back to 1867. But it has 10 other brands most consumers know well including Trojan, OxiClean, Nair, and First Response, which it calls its "power brands" that dominate their respective categories.
Church & Dwight is an acquisitive company. The playbook goes something like this: Church & Dwight purchases brands that have significant share in their category and then improves them, either by slapping the Arm & Hammer logo on them, or by extending them with slight deviations that gives them more space on store shelves.
It's a model that has simply worked, one that you can see for yourself by visiting a nearby grocery store. Take a look at the laundry aisle, where you'll see many different combinations of Arm & Hammer, OxiClean, and XTRA branding. Or venture off to cat litter, where the Arm & Hammer brand makes yet another appearance, parlaying baking soda's anti-odor properties into another highly profitable consumer good.
Profits have increased due to a steady increase in margin on top of rising revenue. The company highlights the fact that 25% of its employees' bonus pool is tied to gross margin, or the difference between what it pays to produce a product and what it books in sales when the product is sold. If there is one thing to learn from Church & Dwight, it's that investors can make obscene returns when the interests of shareholders are aligned with the interests of employees.
Pizza profits turn $5,000 into $87,707 in 10 years
There may be no better turnaround story in corporate America than Domino's Pizza. Ten years ago, the company had a problem: Its pizza wasn't very good, and sales showed for it. Starting in late 2009, it did what few companies would ever do by admitting its pizza was awful.
Domino's spent millions of dollars on TV ads that included critical quotes from focus group participants, including one who said that "the sauce tastes like ketchup." Another said that "the crust tastes like cardboard." Its CEO and head chef appeared to say they got the message that the pizza had to change. Domino's revamped its recipes, focusing on fresh ingredients that, while costlier, resulted in a better taste its customers preferred.
Success was almost immediate, as same store sales rose more than 14% in the first quarter of 2010. But that was only the beginning of a multi-year trend. A recent presentation points out that domestic same store sales grew at an average annual rate of 8% from 2010 to the third quarter of 2017, far faster than any of its quick service restaurant peers.
Domino's has an attractive operating model in that it generates the bulk of its profits from royalties, collecting fees roughly equal to 5.5% of revenue at franchised stores. This capital-light business model enables the company to grow without tying up its own money developing new stores, and thus it turns virtually all of its earnings into cash that can fund share buybacks and dividends.
Though turnaround situations are some of the riskiest investment theses, they can also be the most rewarding. Domino's franchisees reported $133,000 in EBITDA per store in 2016, up from $49,000 in 2008. Domino's earnings have grown even faster, rising from $0.93 per diluted share in 2008 to $5.83 in 2017. Domino's is one of the best-performing stocks over the past decade, turning $5,000 into $87,707 in just 10 years, one pizza at a time.
Jordan Wathen has no position in any of the stocks mentioned. The Motley Fool has the following options: short May 2018 $175 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.