Tuesday, I showed you the secret to the FANG’s success.
For years, these Kings of Capital consistently delivered more profits on the capital investments they made in their business than almost any other company.
They redefined the customer value proposition and applied it to powerfully disruptive trends already underway. And when the cash rolled in, they reinvested it in even higher-returning projects.
Those consistently high returns on capital – or ROC – more than any other factor propelled these four stocks over 1,000% higher since the end of 2012. While at the same time, all other stocks in the S&P 500 managed a mere 1/6th of that.
That’s true wealth building.
And owning wealth builders for the long-term is the true secret to achieving financial prosperity.
Of course, when companies create so much more value than the rest of the market, that draws in competition. And eight years on, there’s no shortage of competitors looking to edge out Facebook (NYSE: FB) in social media, Netflix (NASDAQ: NFLX) for on-demand content, or Amazon (NASDAQ: AMZN) for delivery. Not to mention the pressure to crack down on Google’s (NASDAQ: GOOGL) and Facebook’s abuse of personal data.
So, you can’t rely on yesterday’s successes to build financial prosperity tomorrow.
To build generational levels of wealth today, you need a way to spot the new breed of Capital Kings.
Holding CEOs Accountable
One thing all Capital Kings persistently deliver is a high ROC.
But to determine when a company generates a high ROC, you need to know how much they have invested in capital to generate those profits.
Remember, CEOs are investors too. They take funds raised through issuing stocks and bonds and the cash generated internally from profits and invest in the business. And ROC is the measure of how much return they are generating from those investments.
Now, warehouses, office buildings, factories, and retail space are all capital investments. But you must also count money spent on research and development and brand building through marketing, among other things.
Unfortunately, financial reporting standards don’t treat money spent on R&D and marketing as investments. They get expensed or effectively written off. So, you can’t determine how much a CEO has actually invested in the company by looking at the latest financial statements.
And the Capital Kings of tomorrow invest far more in R&D and marketing than physical property. And to not count those investments gives them far too low a hurdle to outperform.
You need to back out those expenses and add them to capital to hold a CEO accountable for all investment decisions.
For example, Amazon’s latest financial statements reported $114 billion in total stockholder’s equity – the standard measure of investor’s capital. But after correcting for R&D, marketing, and other investment-related expenses, that capital base climbs to $243 billion.
That’s well over double the amount invested in the company reflected in the stockholder’s equity section of a financial report. This means profits must be much higher to generate a high return on that capital.
But once you get the capital right, Capital Kings like Upstart Holdings Inc. (NASDAQ: UPST) are much easier to spot.
ROC Points the Way to Wealth Building Returns
Applying these adjustments to Upstart Financial – a company using AI to disrupt finance – you find a company generating a 45% ROC.
However, the value created from those high returns wasn’t reflected in the stock’S $116 price when I recommended you go long last month.
It’s now trading north of $220. And big moves like that are just the type of opportunities ROC can reveal.
A high ROC was also behind my recommendation to go long Egain Corporation (NASDAQ: EGAN). Its success in applying AI to its SaaS solution has helped drive return on capital from negative 1.7% in 2018 to 27.7% today. And that momentum makes the stock worth at least $18, or 60% higher from current levels.
And a high ROC – along with a disruptive business model – that points out the following wealth-building recommendation I have for you today…
Disrupting the Pharmaceutical Value Chain
Consider buying shares in Harrow Health Inc. (NASDAQ: HROW).
Like a traditional pharmaceutical company, Harrow Health has a few drugs in the pipeline. In the case of Harrow, these drugs focus specifically on eye care.
But Harrow has also built a production and dispensing facilities network to cut out all the typical pharmaceutical middlemen, which negates the need to outsource production, pharmacy benefit managers, insurers, wholesalers, and retailers.
That means a lot more revenue makes its way through to profits. And those higher profits allowed Harrow Health to deliver a 33% return on capital last quarter.
And once you account for all the cash Harrow still has on its books to invest in the business, plus the revenue growth Harrow is expected to deliver, I figure the stock is worth $27 a share.
It currently trades for less than $10. And while I don’t expect as quick a move in HROW as we saw in UPST, you want to get in now to make any sudden gains your gains.
