At one of
Berkshire Hathaway 's (NYSE: BRK-A)
"Woodstock for Capitalists" events (also known as the annual
shareholder meeting),
Warren Buffettdescribed the perfect business like
this:
The ideal business is one that earns very high returns
on capital and that keeps using lots of capital at those
high returns. That becomes a compounding machine. So ... if
you could put a hundred million dollars into a business
that earns twenty percent on that capital -- twenty million
-- ideally, it would be able to earn twenty percent on a
hundred twenty million the following year and on a hundred
forty-four million the following year and so on. You could
keep redeploying capital at [those] same returns over time.
But there are very, very, very few businesses like
that.
Why so few? Think about a top-quality business like
Coca-Cola (NYSE: KO). If Coke reinvested all
of its earnings into the business (which it
doesn't), for a time it might be able to
continue to deliver high returns on capital and compound its
capital base.
But as a company gets increasingly large and has an
ever-growing amount of available capital to deploy, finding
high-rate-of-return opportunities to put capital to work can
become difficult.
So in searching for Buffett's ideal stocks, we need to
look for two things: high current returns on capital and
plenty of opportunities to put new capital to work at
similarly high returns.
Meet the returns royalty
Let's look at which companies are actually earning high
returns on capital. To get us started, I ran a stock screen
for companies with average five-year returns on capital above
15%. Here are a few of the stocks that I came up with.
Company
Market Cap
Capital Base
Average 5-Year Return on Capital
Microsoft (Nasdaq: MSFT)
$220 billion
$45 billion
40.3%
ExxonMobil (NYSE: XOM)
$325 billion
$122 billion
28.7%
Apple (Nasdaq: AAPL)
$167 billion
$21 billion
20.6%
Google (Nasdaq: GOOG)
$155 billion
$28 billion
16.1%
IBM (NYSE: IBM)
$157 billion Continued... |