The Smartest Move Investors Can Make Right Now
Alpesh Patel|October 26, 2022
Editor’s Note: In this market, Alpesh gets asked daily what the smartest move for normal (i.e., non-multimillionaire) investors to make is.
So today, he’s sharing the No. 1 tool he trusts to point him and his followers toward the best opportunities. It’s a tool that has historically been reserved for ultra-wealthy investors. But using it could be the single best way to not just survive market downturns… but come out the other side of them wealthier than ever. And you can see it in action right here.
Let me share with you a unique indicator that could boost your chances of scoring some big gains.
It’s one of my personal favorites.
It’s a metric that’s not as well-known as price-to-earnings ratio (P/E) or even discounted cash flow (DCF), but it’s behind the advice given by two of the world’s largest wealth management firms to their wealthiest clients.
Deutsche Bank invented it. Goldman Sachs Private Wealth Management uses it extensively in its stock selection.
Cash return on capital invested (CROCI) may not sound like an important cause of stock returns…
But it can help you target the stocks that are best positioned to not just survive but thrive.
I first learned about it at a lunch presentation at Goldman Sachs Private Wealth Management. I was seated next to then-Chairman Jim O’Neill when the company’s quantum division (cool name, eh?) made its presentation.
My jaw dropped. I kept the slides (and still have them!).
Now, not every stock with a good CROCI score will generate solid returns… After all, a tailwind boosts returns, while a financial crisis evaporates them. And some sectors do better than others.
I’ve been using this formula since 2010, based on data from the preceding decade. Through bull and bear markets and corrections, it’s been the secret sauce that’s taken portfolios from good to great.
Show Me the Money
In the simplest terms, CROCI measures how much cash a company produces on the capital it has had invested in it. It’s a measure of efficiency. It’s harder to manipulate cash than it is to manipulate earnings or profits. So CROCI paints a truer picture.
The higher the CROCI, the better. (In fact, I invest in only companies with a CROCI score of 10 or higher.)
It’s almost obvious: Companies that produce more cash on the capital they have perform better. They produce more cash by generating more sales and having fewer expenses. For example, if you don’t need to spend lots of money on capital goods (e.g., airplanes), can use the same machinery for years, have fewer staff members and generate lots of sales (demand)… you get more cash.
But of course, that is also too simple. High-return companies have traded at a persistent and substantial premium… yet have significantly outperformed as their assets and cash flows have grown.
Let me explain…
The market is willing to pay a premium for companies with high cash growth. (After all, cash is king.) When we look at the trend of the average top 25% and the average bottom 25% of companies by CROCI, companies with low cash returns tend to generate slower growth, and – no surprise – companies with high cash returns tend to generate faster and more sustained growth.
Research shows that while companies with high cash returns are relatively expensive, they outperform nevertheless. Yet most investors think such companies are too expensive and won’t continue growing.
That’s simply not the case.
This is a hugely important idea.
A structurally well-positioned company should sustain outstanding earnings over multiple years. Assuming it does, the market will continue to value it at a premium.
There is, therefore, an inherent “valuation opportunity” in owning long-term leaders over longer-term holding periods.
Let’s look at a few historical examples from Etsy, Crocs and Best of the Best.
Each of these companies had a good CROCI score. Each was in the top 15% of all companies measured and ranked by CROCI.
They also had good P/E ratios, good sales growth and consistent momentum. But by further narrowing down by CROCI, my team and I were able to laser-focus on these companies in particular… and they soon became market winners.
Etsy – the online marketplace for creators of handmade arts, crafts and other home goods – was able to generate lots of profits when the pandemic began, as its sales were boosted by lockdown buyers.
Those cash sales translated to profits because the company churns out a lot of cash relative to the amount of capital it invests. It is an efficient maker of money. In other words, it is good at turning income into profits because its expenses are low.
For Best of the Best – an online lifestyle competition platform – lockdown viewers started playing the types of games it features more often.
But this wasn’t a gamble on consumer behavior.
We knew that once sales increased, they would have an outsized impact on profits. That’s because the company had a high CROCI (again, that means it’s good at converting cash into profits).
Crocs was a similar case. During the lockdown, people wanted comfort, and the company’s Instagram campaign boosted sales.
We didn’t know the company would launch a campaign or how people would react to it, but we knew it had a great CROCI score. Once we saw sales come in, we knew Crocs would exceed expectations because the company converts sales into profits more efficiently than companies with lower CROCI scores.
It’s pretty simple… and highly effective.
By drilling down to what really moves a stock, you can use one of the biggest hedge fund secrets to achieve truly great returns.
But even better, this is the strategy I use in my elite research service, GVI Investor. See this tool in action and learn how you could have the chance to turn this year’s losses into some of the biggest windfalls of your life… by clicking here.
Alpesh Patel is an award-winning hedge fund and private equity fund manager, international best-selling author, entrepreneur and Dealmaker. He is the Founder and CEO of Praefinium Partners and is a Financial Times Top FTSE 100 forecaster. As a senior-most Dealmaker in the U.K.’s Department for International Trade, he is part of a team that has helped deliver $1 billion of investment to the U.K. since 2005 . He’s also a former Council Member of the 100-year-old Chatham House, the foreign affairs think-tank, whose patron is Queen Elizabeth. For his services to the U.K. economy, Alpesh received the Order of the British Empire (OBE) from the Queen in 2020. As a recognized authority on fintech, online trading and venture capital, his past and current client list includes American Express, Merrill Lynch HSBC, Charles Schwab, Goldman Sachs, Barclays, TD Bank, NYSE Life… and more.