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Stock Screen: High Returns Earned on Total Capital - November 27, 2013
One quick way to cut through the large number of available investments 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 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.
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 high on this measure (subscribers can view recent and historical Index information here). A recent review of the screen turned up several companies worth a closer look, we chose to highlight one here, Ross Stores, Inc. (ROST).
Ross Stores, Inc.
Ross Stores is the largest off-price apparel and home fashion retailer in the United States. The company operates two unique brands of apparel and home fashion stores – Ross Dress for Less (“Ross”), and dd’s DISCOUNTS – which combined, total over 1,100 locations across 33 states, Washington D.C. and Guam.
Its target customers are value-conscious women and men, aged 18-54. The company attracts this group with recognizable labels and fashions at discounted prices. In fact, policy dictates that brand-name products are to be sold at a 20%-60% discount compared to traditional department or specialty store prices.
Ross’s business model requires operating costs to remain as low as possible. This retailer is able to limit labor costs relative to those of full-price stores for a few reasons. First, the value-retail business fosters a very hands-off approach – customers are left to shop on their own, without much sales pitching from retail associates. Labor-saving technologies such as digital price-checkers, self-checkout registers and the like limit the number of employees necessary to run a successful store, while also requiring very few of store employees with product-knowledge, or retail experience. Moreover, most of Ross’ general and administrative costs are centralized; all of the marketing, advertising, and merchandising decisions are made by a singular executive unit and then rolled-out on a nationwide basis. This, coupled with a very simple store layout, which features open spaces and limited construction demands, keeps costs in check.
Nonetheless, this business model is utilized by many U.S. competitors, like The TJX Companies (TJX), Kohl’s (KSS), and Target (TGT). They all offer similar products with only private label and celebrity endorsed lines to meaningfully differentiate them.
Ross’ third quarter sales rose 6%, in line with its guidance. Earnings were up a better-than-expected 11% year over year, largely due to improvement in the merchandise margin. A 2% rise in comparable store sales was driven by a higher average transaction amount. Juniors and missy sportswear were the strongest businesses during the quarter, while Florida was the top-performing region.
For the all-important holiday quarter, same-store sales are expected to increase 1% to 2%, on top of a difficult 5% to 7% comparison last year. EPS are expected to be $0.97 to $1.01, near last year’s adjusted result and our estimate. Still, there might be around 60 basis points of operating margin erosion as the company may get more conservative with the merchandise margin. The company also cautioned about ongoing uncertainty in the macroeconomic and political climates. We think this may actually turn into an advantage for the low-cost retailer, as some shoppers may go brand-name bargain hunting to save this holiday season. Overall, momentum investors may want to take a closer look here.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.