2 Factors Found in Every Transformative Stock

Transformative stocks can make or break a portfolio over the long term. But how can an investor identify these winners ahead of time?

In this video from The Virtual Opportunities Show, recorded on Nov. 30, Fool contributors Demitri Kalogeropoulos, Asit Sharma, and Rachel Warren take on this question, highlighting a company's culture and its ability to efficiently allocate capital. 

Asit Sharma: I'm going to ask Rachel and then Demitri to talk about one or two things that to them represents or serves as a characteristic of a truly transformative company, and maybe the third time will be a charm, we'll wrap up this discussion we started last week.

But Rachel, when you're looking at companies, what separates a really, really great and transformative company from one that, hey, you admired, you think just a fine investment to make. What is that signal? It can be qualitative or quantitative or mix of the two.

Rachel Warren: Yeah, I know we talked about this, it almost feels like trying to pin Jell-O wall a little bit because there's so many things that I think can make a company transformative and also very much depends on what you're looking for as an individual investor. For me, we talk about this a lot here at The Motley Fool about the importance of company culture. I think that's the term that gets thrown around a lot and it can be hard to put a definitive meaning behind.

OK, what is that? Well I think it's interesting to look at, all right, if you're investing in a company and you're searching for a company that has a strong company culture, sometimes understanding what a good company culture is, is understanding what it isn't. I found this really interesting study by Harvard Business Review from a few years back. It was talking about how positive work cultures are more productive, and of course, even more productive company.

That's not only great for the company and its customers, but it's great for investors as well. One of the things that the article noticed was, although there's an assumption that stress and pressure push employees to perform more, better, and faster, what cutthroat organizations fail to recognize is the hidden costs that are incurred.

According to The American Psychological Association, more than $500 billion are siphoned off from the US economy every year because of workplace stress, and 50 million workdays are lost each year due to stress on the job, 60-80% of workplace accidents are attributed to stress. Another thing the study noted was the cost of disengagement within company culture. Engagement and work, which is associated with feeling valued, secure, supported, and respected, is generally negatively associated with the high-stress cutthroat culture.

Disengagement is costly. According to studies by the Queens School of Business and the Gallup organization, disengage workers at 37% higher absenteeism, 49% more accidents, and 60% more errors and defects. I think if you look at those numbers really quick and break it down into what it means, essentially, companies that are more engaged with their workers, they put value on their company mental and physical health, that translates to higher value in the workplace, having a quality benefit package that allows for time off.

Some of these companies we've seen that have done unlimited PTO or a more generous PTO package. When you value your workers, your workers will often work harder for you. When you look at these numbers, broken down into this statistics and percentages, and this was a few years ago, so it's probably more now that $500 billion is taken out of the U.S. economy every year because of workplace stress and incidents related to that, you think about how much more productive some of these companies could be with greater investments in their workers, whether that be better benefits and pay, those are much more concrete thing or perhaps, as well better packages such as employee stock ownership programs, incentives like that I think are very important.

I found this really interesting. I think just to break it down, one thing for me that I find to be really valuable is a company that invests in its employees. I would think about Shopify earlier, their mantra of conformity kills creativity. I think that tells me a lot about how they approach their workplace, and that's the company I want to invest in.

Sharma: Rachel, I can already tell this is going to make it to our final criteria list when we build our prototype company, we've got a couple of minutes left before Demitri takes us out. I don't mean that literally, thank God we [laughs] are separated virtually. I'm just kidding, Demitri is like one of the nicest guys you'll ever meet.

I did want to answer a quick question from Texas Two-step to say that actually the demographics to answer your question about male-female skew in Roblox are pretty interesting. The last I could find, 51% of Roblox users were male, the rest were female, or actually it's 44% and I think the balance would be non-reporting or reporting under other gender.

That is actually a little bit higher representation of female participation versus other platforms. Even when we look at STEM education statistics, something I like about Roblox, and I think that number has been trending upward. We can talk more about that in the future shows.

Demitri, in a couple of minutes, take us out. I would love to hear what you've got for us as a characteristic of a truly transformative company that you want to discuss today, and we will finish this discussion next week.

Demitri Kalogeropoulos: Sure. I'll be quick, but I thought since Rachel was going to highlight such a great qualitative aspect, I thought, I'd pick one quantitative one here.

Like she said, it's a really hard, there's so many aspects, so many moving pieces here, but one that jumps out to me is capital allocation, efficient capital allocation, basically a management team that can manage and spend capital. Because when you break it down, like mathematically, what we want as investors is a company that can take increasingly large amounts of cash and productively deploy that, like it has to be able to turn bigger and bigger piles cash into productive sources.

Anybody can turn $10 into $12, but can you do $100 billion into $120 billion? That's what we're looking for.

The metric that I would like for that is return on invested capital, ROIC, a lot of companies will mention that calculation in their earnings reports and you can find charts that match them. I like using that as a comparison for companies in the same industry, for example. What you end up seeing is the dominant companies in the world, the transformative ones are the ones that can do that over a long period of time. Just one example I highlight because I love so much, it's Home Depot.

Their return on invested capital is up in that 40% range, one of the highest in the entire, definitely in the industry and the market in some ways. It's obviously you want to do your homework and look at a whole lot of other things, but a number like that, that's high and rising, we're like steadily high is usually a good indication that this management team prioritizes how they allocate capital and they have a good system behind how they do it, too. Those are usually really good big checkboxes for me.