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- Don D., California
Stock Screen: High Returns Earned on Total Capital - February 12, 2014
When an investor buys shares in a company, he or she is buying a portion of that company. It is a material commitment of resources. The assumption is that the management team of the selected company can better use the investor’s resources than the investor can, and, thus, earn a return for the investor in the form of distributions (normally dividends) or a higher stock price. A bond investor makes a similar choice, though the expected return is in the form of regular interest payments and a return of the original sum lent to the company. It can be difficult, however, to get a clear picture of how well a company makes use of the resources it has at its disposal.
One quick way to cut through the large number of investments available is to review return on total capital. This statistic measures the percentage a company earns on its shareholders’ equity and long-term debt obligations. Value Line calculates this number, which appears in the Statistical Array on every research report, by dividing net profits plus half of the current year’s long-term interest due by the sum of shareholder equity and long-term debt. The general idea of the measure is to see how much a company earns on the money it has been given by outside investors. Companies with high scores are, presumably, better wards of capital.
That said, this measure is best used as a starting point and a comparison tool. Some industries will never show up on a screen of this nature, others will have many representatives. Thus, comparisons between companies in the same industry will provide more insight than comparisons between companies in different industries. In addition, comparing this measure to return on shareholders’ equity can provide insights into how well companies are making use of debt—if return on total capital rises, but return on shareholders’ equity doesn’t, additional debt financing may not be benefiting shareholders.
Since a quick review of this one measure can highlight companies that are making the best use of investor capital (on a combined basis from stock investors and bond investors), each weekly Index of The Value Line Investment Survey includes a screen listing the 50 companies that score highest on this measure (subscribers can view recent and historical Index information here). To help refine the screen, and remove companies with a temporarily inflated score, we use a five-year time period when selecting the top companies. In addition, the list is sorted by earnings retained to common equity to highlight those companies that are doing the most to benefit their equity investors. A recent review of the screen turned up several companies worth a closer look, including The Buckle (BKE) and Computer Programs and Systems (CPSI).
The Buckle is a retailer of medium- to higher-priced casual apparel for fashion-conscious young men and women aged 15 to 30. At present, the company operates around 450 stores in 43 states, mainly in the central, northwestern, and southern regions of the United States under the names "Buckle" and "The Buckle". The merchandise mix includes denims, casual tops, sweaters, slacks, outerwear, accessories, and shoes. The denim segment now accounts for roughly 46% of total sales, followed by tops and sweaters (31%), shoes (5%), and all other categories (18%).
We believe that fiscal 2014 (which began on February 2, 2014) will be an unspectacular year. Indeed, it appears that a highly competitive environment may continue. What’s more, the company’s youthful customers might remain financially constrained. But The Buckle ought to get its normal share of business due to a wide selection of leading denim brands, including unique styles, colors, and fits. Too, the company is noted for delivering fresh goods to its stores every few days. The key denim line also triggers sales of tops and other items. Nonetheless, it seems that fiscal 2014 share net will be $3.45, just in line with the $3.40 we think The Buckle generated the prior year.
Meanwhile, the company has an aggressive expansion initiative in place. In fact, management has 16 new units planned for this year, with four scheduled during spring, about six during the back-to-school period, and the balance ready for the fall holiday season. The Buckle also has between 14 and 16 full remodels on its 2014 drawing board. These typically cost as much as opening a new store.
Computer Programs and Systems
Computer Programs and Systems engages in the design, marketing, installation, and support of healthcare information technology solutions for small- and mid-size hospitals in the United States. Specifically, it offers enterprise-wide clinical management, access management, patient financial management, and resource planning management, among other systems. The company currently serves around 650 client hospitals in 45 states.
Looking at 2014, the health IT provider will probably continue to pick up some business from its competitors. Since Stage 1 attestation deadlines have already passed, completely new greenfield opportunities have virtually evaporated. Demand from hospitals desiring to replace their existing vendors, however, has been on the rise. All things considered, it seems that this year’s earnings per share will advance in the upper-single-digit percentage range, to $3.10, relative to the $2.85 we expected the Alabama-based company to post in 2013.
The firm’s long-term prospects will depend on its ability to help client hospitals simplify and streamline their daily operations. One exciting area of Computer Programs’ business is consulting services for rural hospitals. With healthcare regulations and requirements likely to increase in the future, some of those smaller rural hospitals will find it a challenge to stay on top of all these changes. In developing and marketing these consulting services, the company ought to benefit greatly from its reputation as a leading provider of health IT services for the small- to mid-size hospital segment.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.