Return on invested capital (ROIC) may be one of the best metrics to find which stocks will outperform the market. Measuring a company's profitability compared to its debt and equity, a consistently high ROIC indicates a wide moat surrounding a business's operations.
For example, the top 40% of ROICs in the Motley Fool's "investable universe" nearly doubled the returns of their lower-ranked peers since 2003 -- and did even better if their ROICs were rising over time.
Averaging ROICs of 19% and 23% since 2000, respectively, Johnson & Johnson(NYSE: JNJ) and Mettler-Toledo International(NYSE: MTD) seem to prove this theory to be true.
JNJ Total Return Level data by YCharts.
Posting market-beating total returns (market-crushing, in Mettler-Toledo's case) over this same time horizon, let's explore what these companies have left to offer investors today and why they still look like no-brainer lifelong holdings.
Spin (off) to win
Fresh off the heels of the spinoff of its consumer health segment, Kenvue, Johnson & Johnson looks to return to its market-beating days of the past. Down roughly 8% to start the year, Johnson and Johnson's total stock return is now trailing that of the S&P 500 index on a one, three, five, and 10-year basis.
However, now may be the time to take a second look at the 136-year-old company and its 12 $1 billion-plus platforms.
Following the spinoff of its Kenvue unit, the company is shifting its operational focus entirely to the healthcare sector. Via its remaining two segments -- pharmaceutical and medical technology -- Johnson & Johnson will build upon its impressive track record of innovation through its high research and development (R&D) spending.
Spending $3.6 billion on R&D in the first quarter of 2023 -- or roughly 15% of sales -- it is no surprise that new products steadily power the company's sales to new heights. Highlighting this point, new products designed in the last five years already accounted for 25% of sales in 2022 -- leaving the company uniquely poised to benefit from a narrower focus on its healthcare segments.
Furthermore, Kenvue's adjusted operating income before taxes margin was 23%, compared to the more impressive figures of 27% and 43% from the medtech and pharmaceutical units, respectively. By removing the more commoditized products in Kenvue's arsenal, Johnson & Johnson's higher-margin and faster-growing segments could help garner a higher valuation, all while boosting its ROIC, which has recently fallen to 11%.
Best yet for investors -- and often for the reasons already discussed -- many studies have shown that spinoffs are a market-beating proposition for both the parent and the spinoff companies during the two or three years after the separation. While we prefer to think over long time horizons, spinoffs can be an excellent catalyst for long-term investors looking for an entry point.
Led by these historical tailwinds of high ROICs, spinoffs, and well-funded, dividend-paying stocks offering market-beating potential, the company's vast pipeline of new products should help propel the company's share price to new highs.
Trading at just 15 times management's expected adjusted earnings per share (EPS) in 2023, Johnson & Johnson and its 60-year streak of raising its 2.8% dividend annually look like a no-brainer given the company's numerous catalysts.
Compounding at its finest
Mettler-Toledo's precision instruments and software maintain many No. 1 and leadership positions across various niche product verticals for use primarily in laboratory and industrial settings. Ranging from balances, pipettes, and titrators to vehicle scale systems, product inspection equipment, and pH meters, Mettler-Toledo sells its products to over 140 countries.
Posting a 9,000% total return since its initial public offering in the 1990s, the company is an excellent example of what steady compounding can do for investors over time.
However, recently reporting first-quarter earnings that saw sales and adjusted EPS rise by 7% and 10%, respectively, the stock's share price plummeted over 10% in the last week due to an underwhelming guidance of 3% sales growth in the second quarter.
Speaking of this weak guidance, CFO Shawn Vadala explained that Q2 of 2022 saw larger-than-normal revenue growth of 27%, hinting that the disappointing guidance was more of a challenging comparable issue than anything operational.
On a brighter note, the company's younger industry verticals continued to show promise. First, its retail food unit grew by 36% in the quarter, while its customers in the lithium-ion battery and sustainable polymer industries showed continued investments. While almost inconsequential to the company's totals currently, these fledgling verticals offer attractive growth optionality to the stable compounding when looking decades ahead.
Powered by a high and rising ROIC of 45%, the company has delivered 6% and 18% annualized sales and EPS growth rates over the last decade -- demonstrating the power of its numerous product leadership positions.
MTD Return on Invested Capital data by YCharts.
Converting almost all of its net income into free cash flow, the company bypasses paying a dividend to return cash to shareholders through share buybacks. Since 2013, management has lowered the company's total shares outstanding by 26% -- further juicing its profitability to shareholders. Proving just how valuable these repurchases are, while net income has increased nearly 200% over the last decade, EPS has spiked by roughly 300% due to the lower share count.
Companies employing a strong and steady approach to share buybacks have also outperformed the market. When paired with Mettler-Toledo's enticing ROIC and leadership positioning, these buybacks and the company's steady nature make it a no-brainer investment to hold for life, even if it trades at a slight premium of 35 times earnings.
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Josh Kohn-Lindquist has no position in any of the stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool has a disclosure policy.
