Every investment comes with risk. After all, if you don't risk anything, then you don't stand to earn a return. But individual investors don't need to bet on unproven, small-cap businesses just to grow their hard-earned money or beat the performance of the S&P 500.
Consider animal health leader Zoetis (ZTS -4.32%) and water utility Aqua America (WTRG 0.80%). Both companies generate healthy cash flow and are relatively insulated from economic downturns. The relatively boring businesses have supported stock gains that have outpaced the total returns (stock performance plus dividends) of the S&P 500 in just about every long-term period. Here's why low-risk investors may want to give them a closer look.
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Dogs, cats, and horses need medicine, too
Zoetis has quietly been one of the best stocks on the market since its initial public offering (IPO) in 2013. Shares have posted a total return of 354% since making their debut, compared to gains of "only" 148% for the index. How has the animal health leader accomplished the impressive feat? Steady growth, a focus on operating efficiency, and a slew of acquisitions.
In the first nine months of 2019, total revenue and earnings before income taxes each grew over 7% compared to the year-ago period. Zoetis converted 24% of revenue into net income in the first three quarters of last year, which allowed the business to grow dividends per share a whopping 30% compared to the same period of 2018.
The details aren't very exciting, but a basic understanding of the company's strengths provides confidence in growth plans. Zoetis generates 51% of total revenue from companion animals (cats, dogs, and horses), although the portfolio accounts for 64% of total revenue in the United States. That provides a high-margin foundation from which to grow and covers for periods of weakness in the livestock portfolio, which actually generated lower revenue in the first nine months of 2019 than in the year-ago period.
There's also more room for innovation in companion animal products, which tend to have larger opportunities in wealthier countries and markets, thus supporting higher prices. For instance, Zoetis expects two dermatology products, Apoquel and Cytopoint, to generate over $700 million in annual revenue in 2019. That would be equivalent to 10% of total revenue. Similarly, American regulatory approval of Simparica Trio, a monthly parasiticide for dogs, could add $150 million in incremental revenue in 2020. The company is also developing biopharmaceuticals, such as monoclonal antibodies, for diseases affecting dogs and cats.
Investors with a long-term mindset should find a lot to like about Zoetis. It has ample growth opportunities and should receive a shot in the arm if and when livestock markets recover. Even when overall growth does finally slow, the business can shift cash flow to dividend payments instead. The stock may not match its epic returns delivered to date, but there's likely more left in the tank this decade.
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Steady growth and a bold bet that should pay off
Aqua America has also handily beaten the S&P 500 over the long haul. The water utility stock has rewarded shareholders with a total return of 326% in the last decade, compared to a 257% gain on the same basis for the index.
Slow and steady growth is essentially baked into the company's business model. As a regulated water utility, Aqua America must make large investments to continuously improve its infrastructure in order for authorities to approve rate increases. That explains why Aqua America has steadily increased capital investments and acquired regional water infrastructure to help bolster its growth potential.
In the first nine months of 2019, total revenue grew 5% and operating income fell 2% compared to the year-ago period. Higher operations and maintenance expenses sapped profitability, but after investing a record $550 million into infrastructure last year, Aqua America's long-term earnings growth remains intact.
Investors can also expect a boost from an unconventional source: natural gas. In late 2019, Aqua America finally had its $4.2 billion acquisition of Peoples Gas approved, meaning the transaction should close in early 2020. To put the size of the acquisition into perspective, the water utility boasts a market cap of just $10 billion today.
Buying the natural gas utility should diversify Aqua America's water-derived revenue and earnings base while serving overlapping geographic locations. Peoples Gas is also growing profits at 8% to 10% per year, compared to 7% annual growth for the company's water operations. If the acquisition closes, is integrated, and delivers as promised, then Aqua America will remain a low-risk stock with ample earnings growth potential for the long haul.