When Jeremy Grantham speaks, I listen. He's not afraid to have a contrarian mindset lead him in a different direction from the crowd. Recently, Grantham believed some high-quality companies traded at attractive prices. Grantham wasn't sure why the high-quality names were on sale, but he thought they offered the best returns for the next seven years. He has a pretty good long-term track record of sniffing out where the best returns are, so let's see what companies Grantham is rooting out.
What do "high-quality" and "on sale" mean? Certainly they will represent different things to different people. For our purposes, let's say high-quality companies have a strong balance sheet and generate excellent returns on invested capital. We'll use free cash flow yield (free cash flow / market cap) compared to the 10-year Treasury yield as a proxy for value.
So a Grantham-like opportunity would have:
1. Net cash position > 0
More cash than debt can indicate a strong balance sheet.
2. ROIC > 15%
Earning a 15% return should be more than a company's cost of capital.
3. FCF / P > 4%
10-year Treasuries are yielding about 3%. We want more return than that.
With the definitions out of the way, let's see if MSC Industrial Direct
As you can see from the table below, MSC Industrial Direct has a positive net cash position on its balance sheet. What's more, the company currently earns a return on invested capital that is higher than its cost of capital. Fools love companies that take shareholder capital and create value with it.
|
Company |
Net Cash |
ROIC |
FCF/P |
|---|---|---|---|
|
MSC Industrial Direct |
108.0 |
14.5% |
4.0% |
|
W.W. Grainger |
(120.3) |
15.4% |
8.3% |
|
Fastenal |
220.9 |
17.4% |
2.8% |
|
Barnes Group |
(339.0) |
5.9% |
12.6% |
How does it stack up to the competition? Grainger's balance sheet has a net debt position but looks attractive otherwise. Fastenal has the highest returns but doesn't meet the free cash flow yield criteria. Barnes Group currently has an ROIC that's too low as well as net debt.
Foolish conclusion
Would Jeremy Grantham buy MSC Industrial Direct? That's really hard to say. After all, he's his own investor. But with quality numbers like the ones above, I have to believe Grantham would certainly give MSC Industrial Direct a good, hard look. And you and I should, too.
