Roper Technologies (NYSE:ROP), and Danaher (NYSE:DHR) are very different companies operating in varying end markets, but they have both significantly outperformed the S&P 500 over the last decade -- by a factor of 3.3 and 2.2 times, respectively. Interestingly, the killer advantage for both companies is actually their business model. Let's take a look at what makes these two companies different and gives them a leg up in the marketplace.
The passing of former CEO Brian Jellison in 2018 caused many to reflect on his extraordinarily successful long-term tenure. However, his legacy will live on in the business model he created and refined over his 17-year leadership of Roper. So, what's so different about the industrial company?
In a nutshell, Roper is a highly acquisitive company ($10 billion worth of acquisitions in the last nine years alone) that specializes in buying asset-light businesses operating in niche markets. It's not so much a question of the kind of industry in which it operates, and more one of whether the acquired business has the characteristics that management is looking for.
As a consequence of this philosophy, Roper has built up a collection of relatively disparate businesses which tend to have high-profit margins and generate bundles of free cash flow (FCF). In a kind of virtuous circle of growth, the FCF generated is then used to pay down debt and make more acquisitions.
Whether its water pumps, meter readers, RFID solutions, or specialty software, Roper's business tend to make a lot of cash. It's a model that's worked over the years and the good news is that the company continues to generate excellent performance and 2019 is progressing according to plan.
As you can see below, Roper has experienced a startling increase in operating margin and FCF generation from revenue in the last two decades, partly down to a shift toward more software businesses.
Turning to the question of whether it can continue, there are two main reasons for hope. First, the company looks to be in very good hands with current CEO Neil Hunn -- he's had senior roles at Roper since 2011 and is committed to carrying on the business model.
Second, it's worth noting that while Roper's capital deployment decisions are made centrally, its businesses are run separately. This means there's a bigger chance that the management of a small business acquired by Roper is going to feel it still has control of the business it built up. In addition, Roper gets the benefit of an experienced management team. It's a win-win situation and one that encourages the belief that Roper can continue its history of being a home for excellent small businesses to grow.
As with Roper, Danaher is known for the reputation of its management -- first under the stewardship of current General Electric (NYSE:GE) CEO Larry Culp and now under the less-discussed-but-just-as-impressive Tom Joyce.
Culp and Joyce are largely responsible for developing the so-called Danaher Business System (DBS) -- a set of customer-centric core principles embodying lean manufacturing process and continuous improvement practices. Danaher's strategy is to buy businesses and then apply DBS in order to raise margin and make them more productive. It was so successful that when Joyce spun off Danaher's collection of industrial businesses, now called Fortive, the new company's management adopted the principles of DBS and called it the Fortive Business System.
Looking into the future, GE investors will be hoping Culp can apply DBS principles in restructuring GE's power business. Meanwhile, Danaher's medium-term future will be decided on the success of the $21 billion deal to buy GE's biopharma business. Given that it looks like Danaher got the business on an FCF yield discount to what Danaher trades at, the deal looks a good one.
If Joyce can set about applying DBS and improve the company's profitability in the process, then the deal will transform Danaher into one of the world's leading life sciences and diagnostics companies. Given
Stocks to buy?
From an investment perspective, both companies appear to be ahead of their plans in 2019, and at the time of writing, their stock prices are both up more than 25% this year. Thus, they both trade on a forward price-to-earnings ratio of around 27 times earnings. That's not a particularly cheap rating, but both companies have high-quality management and strong business models. They are definitely companies to monitor with a view toward picking up when the price is right.