The Asymmetrical Risk-Return of Quality Companies
The Holy Trinity of longevity, optionality and capital preservation
We’ve already dedicated some articles to Return On Invested Capital, the nuances, sources of good vs. bad growth.
In this post, we’d like to highlight one of our previous experiences in private SME M&A as it relates to valuation and business quality. It came up on our Discord (exclusive to annual members).
Being Shortsighted About Initial Valuation vs. Other Drivers of Shareholder Value Creation
We firmly believe that, in both private and public markets, investors often focus too narrowly on initial valuations and short-term returns to shareholders, overlooking the long-term advantages of:
A high ROIIC and quick payback on investments;
Low recurring maintenance CAPEX (whether for tangible assets or capitalized intangibles like R&D; analyzing PP&E relative to sales, ideally measured at historical cost, can help gauge the impact of incremental tangible CAPEX);
Reinvestment opportunities and a willingness to invest for future growth;
Low working capital requirements;
Strong profitability.
These factors are not new to our readers, so we won’t rehash all the details from our previous posts.
ROIIC isn’t just useful for analyzing growth companies; it’s equally relevant for stable companies, as nothing in business is constant—whether it’s working capital, margins, or inflation.
For many investors, the primary concern is the initial earnings yield, particularly how much of it accrues to shareholders. However, this perspective overlooks critical factors such as cash flow volatility and investment risk. Let’s delve deeper into why steady, quality compounders are often mispriced.