A high and rising return on invested capital (ROIC) has proven to be an excellent metric for investors hoping to find outperforming stocks.
While this is not a one-size-fits-all solution as many growth businesses have yet to reach profitability, looking at stocks in the top quintile of ROIC percentage can be a fantastic way to look for compounders to buy and hold.
This is the case for the two companies we will look at today: Adobe (ADBE -1.73%) and Ulta Beauty (ULTA -2.73%). Ranking 67th and 6th, respectively, in terms of ROIC among their peers in the S&P 500 index, these stocks offer high and gradually rising ROICs.
Data by YCharts.
Let's see why these supercharged businesses look like great candidates to turn $3,000 into $9,000 within 10 years.
1. Adobe
As a pick-and-shovel play in the content creation industry's version of the California Gold Rush, Adobe's leadership position in creativity across the digital landscape cannot be denied.
Through the company's PDF services in its Document Cloud and the vast array of apps available to users in its Creative Cloud, Adobe has built a powerful subscription-based model that has led to its stock rising 850% in the last decade.
This increase is even more impressive considering that Adobe has dropped over 40% year to date due to decelerating growth and a stunning $20 billion price tag for acquiring Figma.
In the wake of this year's decline, the stock trades at a price-to-free-cash-flow ratio of 22, a level it has not seen in nearly 10 years.
Data by YCharts.
Furthermore, despite being well known for its Document and Creative Clouds, its younger Adobe Experience Cloud promises to become the driving force behind the company's stock price.
Allowing enterprises to deliver real-time, personalized experiences to their customers on a massive scale, the young unit grew sales 15% in the fiscal third quarter and now accounts for roughly one-fourth of Adobe's revenue. Being named a leader for six consecutive years in the Gartner Magic Quadrant for Digital Commerce, Adobe Experience Cloud's dollar-based net retention (DBNR) rate of 120% is no surprise.
DBNR shows how much more existing customers spend compared to the prior year, including customers lost to churn. With an impressive 120% rate, the company's land-and-expand business model looks more robust than ever. Further highlighting Adobe Experience's growth alongside its customers is that its oldest cohort from 2012 now spends eight times more on average than they did versus their original subscription totals.
As this land-and-expand process continues to mature over time, Adobe's ROIC could continue improving. Reaching higher efficiencies via lower customer acquisition costs and better margins from existing clients using more of its products, this unit should only grow stronger.
With an ROIC that has steadily risen from 12% to 27% over the last five years, Adobe Experience's high DBNR and importance to the digital economy make its discounted stock a great contender to triple over the next decade.
2. Ulta Beauty
Home to over 37 million loyalty members, Ulta Beauty has grown to account for roughly one-third of the broader "beauty" market. This beauty category consists of hair care, skincare, cosmetics, fragrances, and more, which Ulta serves via its 25,000 products from over 600 brands -- including its private label.
With 1,300 stores, 100-plus shop-in-shops at Target locations, and Ulta.com, the company has quickly become an omnichannel force, seeing its shares more than double and quadruple in the last five and 10 years, respectively.
Recording sales and earnings per share (EPS) growth of 330% and 750%, respectively, over the last decade, Ulta not only maintained profitability throughout the pandemic but has posted new highs since.
Data by YCharts.
One eye-catching metric highlighting Ulta's burgeoning brand power is that 95% of its sales come from its Ultamate Rewards members. This incredible adoption goes a long way in explaining how Ulta ranked 19th on Comparably's Top Brands for Gen Z in 2022. This loyalty program also helps the company learn precisely what its customers are looking for, providing discounted research and development.
After growing sales and net income by 17% and 28% year over year, respectively, in the third quarter, Ulta still only trades at 21 times earnings. Considering that except for one year during the pandemic, Ulta's ROIC has risen from roughly 25% in 2012 to 56% this year, this valuation may be too cheap when considered in the context of its steady growth.
Furthermore, with 78% of female Gen Z beauty shoppers considered beauty enthusiasts, Ulta's leadership position looks poised to grow alongside its younger customer base, making it a great investment to triple over the next decade.
