On average, the S&P 500 returns about 9-10% a year over the long term. A large amount of money managers and retail investors are unable to beat this return over the long run even though it's not that high of a hurdle to overcome. In this post, we'll outline a passive buy-and-hold strategy that uses ROIC and revenue growth to beat the market. We think this is very simple to understand and implement.
How to Beat the Market
Whether you're new or not to investing, if you're reading this, it's because you want to pick your own stocks and beat the market.
We've outlined a VERY simple market-beating strategy here titled How to Beat the Market With Founder-Led Stocks. We suggest reading it because that strategy has proven to consistently beat the market by a very large margin over the long-term.
In another post, we also outlined 10 things to look for when picking stocks to invest in. You can check that out here, it's a great guideline in our opinion and has really helped us make money.
Although we think you should read those posts linked above, today we'll be talking about another simple market-beating strategy that takes very little effort to implement.
Disclaimer: Past performance is not indicative of future results. This strategy has worked in the past, but there is no guarantee that it will still work going forward.
What's the Strategy?
If you happened to read our article that we mentioned above, you'll know that 2 of the 10 things we look for in stocks are: high returns on invested capital and steady revenue growth. We don't just stop our analysis there, but in this article we're going to prove how that's really all you need to beat the market (although adding more proper analysis helps even more).
Strategy: Look for high returns on invested capital and steady modest revenue growth.
What we mean by this: High returns on invested capital (ROIC) to us means 20%+ and modest revenue growth is 10%+ per year. The higher these numbers are though, the better.
The criteria for the backtest: We randomly picked companies that had an average of 20% or higher ROIC from 2011-2015 and companies that had a 10% revenue CAGR during the same period. Why 2011-2015? Well, because we are pretending that we did this analysis in Q1 of 2016 when all the full-year 2015 financial results were released. Then, we hypothetically bought all the stocks that met the criteria and just held them the entire time.
We also excluded materials, financial, and real estate stocks and avoided penny stocks/small caps. We took the financial numbers from the fundamental analysis platform Finbox.
Proof that it works: When randomly selecting tickers based on the criteria, here are the results (image below). For this particular test, we picked 19 US-listed stocks (equally-weighted portfolio) that you can see under the performance chart. Some of these stocks include well-known blue chips like AAPL and SBUX, but there's also lesser-known stocks like SNBR and NVR. Overall, these stocks returned 314.67% in the past 5 years vs 98.52% for the SPY.
Note: The performance charts below are unadjusted for dividends. Adding dividends to the SPY would boost its returns by about 20%. It would also boost the high ROIC stocks' returns, but we don't know exactly how much.
High ROIC + rev growth performance:
These numbers themselves are pretty impressive right? They beat the market by a very large margin. They can get higher if you make some adjustments. If you include foreign stocks in the mix, the performance goes from 314% to 369.73%. Adding foreign stocks bumped up the list to 26 holdings which you can see below.
High ROIC + rev growth + foreign stocks performance:
The compounded annual growth rate (CAGR) from this investment style in the past 5 years was about 36.26%.
In other words, a $1000 investment would be about $4697 and if you *somehow* kept up 36.26% returns for 10 years, you'd have over $22,000 by the end of it. It's hard to sustain those high returns for 10 years though, especially if we're just using this one basic strategy and ONLY buy-and-hold style investing.
How to Find These High-Quality Companies
Well, we basically wrote a whole post about this here but let's briefly explain in this post too. The easiest way is to use the screener available on Finbox. Click here for a link to the screener we used to help us pick the high ROIC and revenue stocks above.
You can make the screener as complex as you want with many metrics to choose from. We just wanted to keep it simple for this article, but we definitely invite you to check out our article mentioned above for more detail on what we look for in stocks. Below is the screener.
Here are some stocks that it spit out.
If you find a stock you like, let's say we pick the stock TPL from the above list, then you can check out its numbers individually to see if it's really any good. Below, is an example of TPL's historical ROIC. As you can see, its ROIC is very high, sometimes over 100%. Revenue growth is also high (with the exception of COVID), but you can search that up for yourself, you get the point.
Just based off of these 2 factors, TPL is a great stock, and guess what: It has returned close to 900% in the past 5 years. Not bad at all.
How Does High ROIC Hold Up Without the Revenue Growth?
In case you were wondering if ROIC can be used just by itself, the answer is yes, it just won't be as good. A portfolio of 35 stocks with high ROIC from 2011-2015 returned 225% vs 98.52% for the SPY. This proves that ROIC is useful but revenue growth is also important to consider for big gains in stocks. Other important metrics are profit margins and cash flow growth and "soft skills" that can't be fully quantified with numbers.
High ROIC performance:
Another Market-Beating Strategy
Perhaps the easiest market-beating strategy is just to buy founder-led stocks. It's such a simple strategy and below are the results. We go into lots of detail about this strategy here and how to find these stocks if you're interested in reading, so we're not going to bother explaining it too much here.
Founder-led stocks performance:
If it's So Easy, Why Doesn't Everyone Just Beat the Market?
The answer to this is simple: Emotions, fear, and greed. These are 3 things that can destroy investment performance. Investing is simply about buying great companies (preferably at great prices) and letting these companies do the work for you.
Retail investors often get caught up in these manias or "new paradigms" and buy into hype stocks that make no money after they've gone up several hundreds of %. Then, they get caught in big sell-offs after bubbles burst and become discouraged and make more irrational decisions.
Or, people can try to get cute and invest in the next "Amazon" before it goes big. This often leads into buying some random unprofitable penny stock that no one cares about and probably never will.
Or, investors may actually buy the right high-quality stocks but get discouraged when their prices go down or sideways for a bit. Then, they end up selling at basically the worst time (just before the stock proceeds to go higher). Stocks become LESS risky as they go down and MORE risky as they go up. For some reason, people feel more risk when prices go against them.
Another big thing that affects investment performance is not ignoring all the noise in the market. There's always going to be an argument for why the market should "crash" and why you should sell everything. Zoom out on the S&P 500. It has basically been going up since when it began if you look at it that way. Economic forecasts can be tricky and misleading. If you're not enough of an "expert" to make your own economic forecasts, then chances are you should just keep investing little by little. Worst case scenario: the market crashes, you average down during the crash, and you end up making your money back and more in a few years (assuming you bought quality companies). Just don't overleverage or invest money that you're not willing to lose and you'll be fine.
There's also the noise of people saying bad things about the stocks you're invested in. At the end of the day, most people have NO idea what they're talking about when it comes to analyzing stocks. If you have a good reason to be invested in a particular stock, stay invested.
Avoid the noise. Avoid buying into "hype". Be patient. Invest in quality. If you know what you're doing, actively manage and rotate your holdings to maximize performance. If not, just buying and holding with this basic strategy mentioned above *should* beat the market.
Beating the market isn't as hard as some people make it to be. Just be logical, do your research before investing, and avoid the noise.
Investing just based off of high returns on capital is an almost surefire way to beat the market. It's nothing new. That's what investors like Warren Buffett and Charlie Munger look for.
Combine revenue growth in the mix and your returns are magnified. Combine other factors like expanding or stable profit margins (due to competitive advantages), good valuation, and other things discussed here, and you should be able to easily beat the market.
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Also, as we mentioned before, we use Finbox for our fundamental analysis and we highly recommend it (we are affiliated with them, but we use their platform religiously). Finbox gives you access to accurate, up-to-date information on any stock in the world with over 900 million data points and 1000+ metrics to choose from. It also provides advanced stock screeners, investment ideas, and more. Learn more about Finbox here