Roper Technologies (NYSE:ROP) is a remarkable company, and it fully deserves to be looked at in the same light as Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). In fact, its performance over the last few decades has arguably been much more impressive. Here's why the multi-industry industrial company is worth considering as a stock investment by Warren Buffett followers.

Berkshire Hathaway and Roper Technologies

A quick look at the share-price performance of Roper Technologies tells you a lot about how well the company has been run in the last few decades. In fact, it has significantly outperformed both Berkshire Hathaway and the S&P 500 index.

ROP Chart

Data by YCharts

What Roper and Berkshire Hathaway have in common is a focus on buying businesses with certain characteristics rather than adopting a highly focused sector approach. That said, any investing strategy that focuses on certain metrics, say high operating margin, return on assets, dividend yield, or sustainable free cash flow (FCF) will unintentionally result in some sort of style or sector bias. For example, distributors tend to operate with relatively low margins; nobody ever bought an early-stage biotech company for its current dividend.

At Berkshire Hathaway, Warren Buffett is known for favoring businesses with strong market positions. Buffett is understood to favor businesses that can improve the return on assets they generate over time -- not something that necessarily relies on revenue growth. As such, it's an approach that, intentionally or not, has led Berkshire Hathaway to be overweight in financials and consumer staples. But what about Roper Technologies?

Stacks of cash in the shape of a bar chart.

Roper Technologies has made a lot of investors wealthy over the years. Image source: Getty Images.

Roper Technologies business model

Roper's strategy was developed by the late Brian Jellison. The longtime CEO of Roper pioneered a business model with the following characteristics:

  • Acquire asset-light businesses operating in niche markets with high operating margin and cash flow.
  • The acquired companies are then run with a high degree of autonomy (aided by coaching from Roper's management), but capital allocation decisions will be made centrally.
  • The cash flow generated from the businesses will then be plowed back into paying off debt and making new acquisitions.

Clearly, this strategy has a lot in common with how Buffett buys businesses to operate under the Berkshire Hathaway umbrella. However, in Roper's case, the insistence on asset-light businesses has increasingly guided the company toward software. In fact, the name of the company was changed from Roper Industries to Roper Technologies in 2015 partly to reflect the shift in the business mix toward technology.

At the end of 2019, Roper owned some 45 businesses, and according to management, the vast majority of them are No. 1 or No. 2 in their end markets. Here's a look at the composition of Roper's revenue. The majority now comes from software and systems. In addition, note that every segment has a very high margin.

Roper Technologies 2019

Key Activities

Revenue 2019

Segment Operating Profit Margin

Application Software

Software across a range of industries, including law firms, heathcare, construction, supply-chain logistics

$1.59 billion

25.5%

Network Software & Systems

Software and systems that create networks/marketplaces in construction, trucking, insurance, healthcare, toll roads, and food

$1.53 billion

35.2%

Measurement & Analytical Solutions

Collection of businesses providing industrial measurement

$1.60 billion

31.4%

Process Technologies

Sensors, pumps, and controls for the process-automation (continuous flow of raw materials) industries

$653 million

34.6%

Data source: Roper Technologies presentations.

Not only does Roper have high-margin businesses, but the fact that they are asset-light means they don't require a lot of capital spending. In addition, Roper doesn't carry a lot of inventory. All this comes together to produce a highly cash-generative company.

For example, in the charts below I've compared Roper to two other multi-industry industrials. As you can see, capital spending, or capex, is very low as a percentage of revenue. Moreover, Roper turns over its inventory at a very high rate; it doesn't need to tie up cash in holding inventory on hand. Indeed, the company's working capital requirements are actually negative and contribute to cash flow rather than take away from it.

ROP Working Capital (Annual) Chart

Data by YCharts

Roper's highly cash-generative business model has resulted in rapidly growing revenue and margin expansion over the years.

ROP Free Cash Flow Chart

Data by YCharts

Looking ahead

Roper occupies a rather unusual genre in the investing world. It's a highly acquisitive company but not really an industry consolidator. In addition, it's growing revenue fast, but its business model is about buying the right type of businesses rather than taking advantage of the benefits of scale. This uniqueness likely means it can continue being successful.

Probably the biggest risk to Roper not having another decade of success would be if management abandoned its business model, or if operating margin started declining as a consequence of Roper failing to find new high-quality niche businesses to buy. However, given that there's no sign of either happening right now, investors have cause for optimism.

There's nothing to suggest that management can't continue to do this, and the COVID-19 pandemic may well create opportunities. For long-term investors, probably the best way to judge matters is to keep an eye on the evolution of this stock's operating margin over time.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.