Beautiful Growth Companies, part II

Back in April, we published a post entitled "Beautiful Growth Companies," in which we highlighted some of the quantitative indicators of the kind of well-run growing companies that our discipline builds upon as the foundation of a long-term wealth management plan.

While noting that "no mathematical formula alone can be relied upon to aid in identifying growth companies," in the words of T. Rowe Price, we noted that the "statistical guidelines" he set out included:

1. A return on invested capital of 10% or better, and continued increase in capital from retained earnings.

2. Above average profit margin for the industry in question, and a favorable trend of improving the profit margins.


3. Compound annual earnings growth of better than 7%.

We revisit these statistics, and the company we used back in April to illustrate them, both to emphasize what we said earlier this week about earnings of certain companies continuing to grow strongly in spite of the gloomy outlook being broadcast about the state of the economy, as well as to illustrate an important point about the ownership of certain types of companies in the face of inflationary pressures caused by the Federal Reserve.

Yesterday after the market closed, medical waste disposal company Stericycle* (which we highlighted in the April 28 post) reported earnings growth of approximately 23% from the year-ago quarter and beat the consensus analyst forecast by two cents per share in the process.

In terms of the three criteria listed above, Stericyle's ROIC increased to 11.7% from around 11%, they were able to maintain a profit margin of 25.7% in spite of diesel cost increases of 57% from the year-ago quarter (a margin decrease of just 0.2%), and the company has a long-term EPS growth rate of 17% (including ten consecutive quarters of double-digit organic earnings growth).

Not only is this company a stellar example of the kind of companies that our investment process seeks to identify and own for clients, but also illustrates a very important point we have made previously about growing companies as a historically-proven store of value in the face of the threat to purchasing power posed by inflation.

Jeremy Siegel argued in an article we linked to previously that stocks can protect against inflation because "the earnings of a firm will rise as the price of its output rises with inflation" and he presented graphs showing the superiority of the historical returns of stocks even against traditional inflation hedges such as gold or commodities.

Stericycle's ability to retain its margins even in the face of the fuel inflation noted above is specific recent evidence of this principle. Note that not every company has the same ability to pass along energy costs, but certain factors in Stericylce's business model, including the indispensable nature of the services that they provide to hospitals, doctors, and dentists, make their company an ideal example of this concept.

Recent earnings news continue to validate the concepts we have written about previously, and to bear out the principles that we have relied on for decades and that have been passed down from previous generations of money managers.

* The principals of Taylor Frigon Capital Management own shares of Stericyle (SRCL).

For later posts dealing with the same topic, see also:
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