What the best stocks in the world look like
We analyzed the financial data of the 100 favorite stocks backed by the world’s top fund managers to understand what they think a top stock looks like. These are the 100 stocks that the world’s top 5% managers support with the greatest conviction, out of the 7,000 stocks they collectively own.
We believe our analysis of the numbers provides fascinating insights into the type of investments that make elite fund managers successful.
Basically, what excites the best investors in the world are stocks that are slightly expensive, but offer exposure to exceptional companies. These are companies with high quality operations and strong growth prospects, all topped off by strong share price momentum.
One could think of these stocks as “value” stocks in the holistic sense espoused by the likes of Warren Buffett.
In for money
In terms of price, the median valuation among the top 100 stocks is high but not outlandish.
Based on forecast earnings for the next 12 months, the average price-earnings ratio is 21 times. This compares to the MSCI World Index PE ratio of 14 times. The top 100 average values from which we derive our median PE is a French chemical company Air Liquide (FR:AI).
Meanwhile, the median free cash flow yield — a valuation metric that many consider less problematic than PE — is 4.2%. Again, this seems high but far from painful. The stock that represents this midpoint among the top 100 is the French call center and chatbot specialist Teleperformance (FR:TEP).
On the way to growth
The top 100 stocks have impressive growth credentials. Importantly, expectations have actually tended to improve rather than deteriorate of late, as the prospect of a recession looms ever larger. One caveat is that analysts are notoriously slow to assess downturns, and current market forecasts seem to be no exception.
In terms of historical growth, our top 100 average has been impressive in terms of revenue and has done even better in terms of results thanks to rising profitability.
Five-year median compound average growth rate (CAGR) of sales is 14% – UK discount retailer B&M European Value Retail (GB:BEM) represents the median company on this score – while the five-year earnings per share (EPS) CAGR is a mouth-watering 18% – American electronics group II-IV (US: IIVI) is the median.
EPS growth forecasts are also impressive. For our top 100 elite stocks, the mid-term forecast for growth over the next 12 months is 14% – with a US healthcare provider United Health (US: UNH) representing the median forecast – and also 14% for the following 12-month period – the median position is shared by United Health and Teleperformance.
And there is good momentum behind broker forecasts. The median consensus forecast update for our top 100 over the past three months was 3.9% – the median stock on this score being the top luxury liquor brand in China Kweichow Moutai (CN:600519) – and 23% over the last 12 months – a median position shared between the American payments giant Mastercard (US: MA) and, again, the moderately excellent Teleperformance.
A matter of quality
Growth only has shareholder value if a company’s operations are of sufficient quality. EPS growth destroys shareholder value rather than creating it if the returns on capital invested to produce the growth are less than the cost of capital employed.
No worries for most of the first 100 stocks. Conventional measures of business quality look impressive.
The average operating margin of the 100 companies is 17.2% – specialist in industrial gases and hydrogen listed in the United States Linde (US: LIN) is in the middle of the pack on this measure – while return on capital employed is a solid 13.8% – that would again be Teleperformance.
The top 100 stocks appear to show a tendency to create value from investments in intangible assets, such as intellectual property, software and brands, relative to tangible assets, such as real estate and machinery.
The median level of research and development (R&D) expenditure relative to sales over the past five years was 5.9%. The company occupying this middle position is the Japanese electronics giant Sony (JP: 6758). Midpoint of five-year capital expenditure (capex) to sales is below 5.1% – Japanese IT consulting and industrial machinery company Hitachi (JP:6501). One caveat is that we have more data from our 100 related to capex than to R&D.
With financial health being another important part of any assessment of company quality, it’s heartening to see that, on average, the balance sheets and cash flows of the top 100 stocks look strong.
For companies that have borrowings, median net debt looks very manageable at 1.4 times EBITDA – Swiss Sustainable Building Materials Group Sika (CH:SIKA) is the society at the midpoint. Meanwhile, the median cash conversion based on pre-tax operating cash flow to Ebitda is 96% – American medical device company Danaher (US: DHR).
Forward and upward
There’s no point in owning stock in a big company if no one else agrees with your reasoning and the stock price languishes. While many of the top 100 elite stocks are far from household names, the stock price dynamics suggest they have enough fans nonetheless.
At this point, we will shift our focus from the “median” to the “mean”, which is a more meaningful way of looking at price movements.
The average stock price performance of the top 100 is strong over one month, slightly outperforming the MSCI World Index. It is impressive over three months and staggering over one year at 4.0% against -10.5% for the index.
So this is it. From the perspective of a series of key financial data points, the average top 100 elite stock looks like an investment opportunity that is far from average.
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