One common flaw that many investors have is an inability to view their stocks as partial ownership in a real, living, breathing business. This tendency leads many of us to impulsively screen stocks based on charts, formulas, and ratios. But is that how we’d really judge a company’s performance if we were the owner?
Of course not. That’s why I suggest that all investors do their best to view a stock as an actual business that they hold part ownership in. The tricky part, naturally, is to figure out what makes a successful business.
Plotting the right course
So much is made of a stock’s price from quarter to quarter, but few investors ever stop to evaluate the business model. Poor business models are the biggest reason that some companies with wonderful products, take Pandora for instance, struggle to earn consistent profits. In the world of business plans, low cost structures rule. If you can have a low cost structure, and a rabid following of devoted customers, that’s even better.
Three businesses that exemplify this wonderful mix of low cost structure and a wonderful customer basis are Starbucks Corporation (NASDAQ:SBUX), Panera Bread Co (NASDAQ:PNRA), and eBay Inc (NASDAQ:EBAY).
To say that these companies, and their stocks, are doing well is beyond obvious. All three companies are trading at multi-year highs, but why?
How has Starbucks Corporation (NASDAQ:SBUX) been able to grow earnings over 15% at its size, and how the heck has eBay Inc (NASDAQ:EBAY) increased EPS a whopping 52% over the past five years? Does it really make sense that Panera Bread Co (NASDAQ:PNRA) has been able to increase in value three times over since 2010, while still trading at a low price to earnings growth ratio of just 1.3? It all makes sense, if you’re looking in the right places.
ROIC: A compass in the search for low cost business models
I’m always amazed at how hard it is to find a company’s return on capital. This metric is not easily or readily found on any major stock screening sites, but it sheds so much light into a business’ health. Return on invested capital measures a company’s return relative to all of the money (debt, salaries, assets, etc.) that is put into a business. In short, it’s exactly how you would measure your performance if you owned a business.
Many companies increase earnings by spending recklessly. A company might pull off a costly acquisition or over-expand stores, even amid declining margins and returns. All of these moves will make earnings per share growth seem wonderful, even if the business is secretly doing much worse.
Which brings us to Starbucks Corporation (NASDAQ:SBUX), Panera Bread Co (NASDAQ:PNRA), and eBay Inc (NASDAQ:EBAY). All three businesses have increased earnings at a meteoric pace. But look at the chart below, the staggering fact is these businesses have earned a higher return on every dollar invested, even as they’ve achieved rapid expansion.
EBAY Return on Invested Capital data by YCharts
Further to the point, check out the chart below following capital expenditures. It’s quite amazing that as all three of these businesses went into hyper growth, their expenditures actually went down! This definitely confirms that the business’ high returns on capital are that “sweet spot” mix of increased sales, due to happy customers, and low costs.
EBAY Capital Expenditures TTM data by YCharts
What’s so amazing in the case of Starbucks Corporation (NASDAQ:SBUX) and Panera Bread Co (NASDAQ:PNRA), is how hard it is to reduce capital expenditures in their particular lines of business. Capital expenditures are new investments in things like buildings and equipment, as well as upgrades. For restaurants and retail stores to grow they have to build new locations and upgrade equipment.
So the real question is, how did this happen?
Conclusion: it’s the business plan!
Yes, you guessed it, we’re ending this tale right where we started it–and with a question. Let’s start with the question first: what do coffee, online auctions, and bread have in common?
Well, answering that question is as simple as:
1) eBay Inc (NASDAQ:EBAY)’s business model is unique in that it is a massive retailer with no inventory. All eBay Inc (NASDAQ:EBAY) does is connect sellers with buyers, it doesn’t manufacture products or resell them. This keeps eBay’s costs low. It saves eBay millions of dollars that companies like Wal-Mart Stores, Inc. (NYSE:WMT) and Gap have to spend in areas like storefronts, warehouses, and operations.
2) Panera Bread Co (NASDAQ:PNRA) is a remarkable company in that it is able to charge much more for its food than fast food companies like McDonald’s Corporation (NYSE:MCD), but it has similar costs. Panera sells sandwiches for double or triple what McDonald’s does, but it skips out on paying for high priced staff, heavy duty cooking equipment, and more. The company doesn’t even have dish washers or waiters, but I guarantee a lunch at Panera will cost you nearly as much as Chili’s.
3) You can’t have a conversation about costs without mentioning Starbucks Corporation (NASDAQ:SBUX). This company invests very little in the way of equipment and food costs, yet its beverages sell for double what Dunkin’ Donuts charges.
These businesses, all for different reasons, have managed to keep customers happy and costs low. In the case of Panera and Starbucks, their brands are so focused on quality that customers are happily paying more for their products than for competitors.
Everyone’s paying more for a sandwich at Panera Bread Co (NASDAQ:PNRA) or a coffee at Starbucks–except for Panera and Starbucks Corporation (NASDAQ:SBUX)! And dollar for dollar, earnings at eBay Inc (NASDAQ:EBAY) are more valuable than other retailers, because their low cost structure reduces risks associated with inventory and real estate costs.
These businesses are keeping their costs low, which is making their stocks go up. If you really want to think like an “owner of a business,” you can’t do better than this!
The article Invest Like an Owner With These 3 Stocks originally appeared on Fool.com and is written by Adem Tahiri.
Adem Tahiri owns shares of Starbucks. The Motley Fool recommends eBay, Panera Bread, and Starbucks. The Motley Fool owns shares of eBay, Panera Bread, and Starbucks. Adem is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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