If you launch a business, you want every rand, naira, or shilling that you invest in it to generate as much profit as possible. After all, there’s no sense investing R100,000 to set up a restaurant if you only expect it to make annual profits of R5,000. You’d be better off simply investing that money in treasury bonds because you’d get a better return without any work or stress.
The same logic holds when investing in shares. When you buy stock, you are buying a little piece of the underlying business. So, you want that business to spin off cash at a rate high enough to justify your risk.
You can figure out that rate with one underused metric — return on invested capital, aka ROIC.
ROIC is calculated in a number of different ways, and the most exact ones are pretty tedious. But here’s the quick and dirty method:
ROIC = (Operating Profit – Taxes Paid)/(Equity + Long-term Debt)
The resulting percentage tells us roughly how much cash a company generates for every dollar it has deployed. A high ROIC suggests the company has found a competitive advantage. If you can pick up the shares of such a company at a reasonable price, there’s a good chance that it will make you a very happy shareholder over the long-term.
Here are eight African companies that have averaged a very high ROIC over the past five years.
8. Nigerian Breweries
ROIC (Five-Year Average): 36.4%
The proud purveyor of Star Lager, Nigeria’s largest brewery has leveraged strong brand loyalty and thin competition to tap a stout ROIC. But while the five-year average profitability looks quite good, it conceals a negative trend. The declining return was precipitated by the use of long-term debt to fund working capital.
7. Pick N Pay Holdings
ROIC (Five-Year Average): 36.9%
Another company that’s rested on its laurels in recent years, Pick N Pay was once South Africa’s leading retailer, but sloppy supply-chain management took a big toll on profitability. Thus, the 36.9% average ROIC is deceiving. It was just 29% during the company’s 2013 fiscal year. But with a new CEO who formerly headed U.K. retailer Tesco, shareholders are hopeful for a turnaround.
6. Clicks Group
ROIC (Five-Year Average): 38.4%
Clicks operates nearly 600 health and beauty stores across South Africa. As might be expected, its income margins are razor thin. In fact, the net margin was just 4.4% over the past 12 months. But it makes up for this in volume. Clicks effectively sold out its entire inventory nearly eight times during the 2012 fiscal year.
5. Unilever Nigeria
ROIC (Five-Year Average): 38.7%
A manufacturer of a wide range of foods and household products, Unilever Nigeria has benefited from Nigeria’s rising population and the increasing disposable income of its growing middle class. But buyers beware! With a price earnings ratio of 4o, it won’t take much of a misstep to send the shares tumbling.
4. Nestle Nigeria
ROIC (Five-Year Average): 39.0%
Unilever’s chief rival, Nestle Nigeria is that country’s leading food and beverage manufacturer. Interestingly, nearly 40% of its sales is derived from its Maggi seasoning brand. Who knew you could make that much money selling bouillon? Also not cheap, Nestle trades at 45 times its 2012 earnings.
3. SPAR Group
ROIC (Five-Year Average): 39.2%
This South African grocery wholesaler has the thinnest of margins (a 2.5% net margin last year), but that hasn’t stopped it from returning 39% on every rand it invested over the past five years. The Rainbow Nation’s economy hasn’t been the easiest of business environments of late, but Spar’s sales growth has remained at a healthy 10%.
2. Truworths International
ROIC (Five-Year Average): 40.1%
The largest clothing retailer listed on the Johannesburg Stock Exchange, its shares have plummeted 22% this year. Sales growth has slowed as cash-strapped South African consumers put a curb on spending. But as its 40.1% ROIC indicates, Truworths is a quality company with continent-wide ambitions, so bargain-hunters may want to start watching this one.
1. Mr. Price Group
ROIC (Five-Year Average): 40.7%
A homeware and apparel retailer, Mr. Price combines solid margins with heavy volume to post a ROIC that essentially gives every rand management invests in the business a payback period of just two years. The Durban-based company even managed to grow earnings 22% during the first half of this year despite South Africa’s consumer confidence hitting a 10-year low.
In conclusion, keep these high-ROIC companies on your watch list. They don’t look cheap, but quality typically comes at a price.