Friday, June 5, 2015

The linkage between returns-on-capital and competitive advantage...

From The Small-Cap Advantage: How Top Endowments and Foundations Turn Small Stocks into Big Returns:
The small-cap manager should attempt to understand the linkage between returns-on-capital and competitive advantage. The latter drives the former, but the former is also indicative of the latter. If an analyst discovers that a company exhibits high returns on capital employed for long time periods, it is likely that the descriptive qualities of the business will reveal a competitive edge. This symbiosis may support the case for a quantitative screen using returns on capital as a factor; however, companies that exhibit sustainably high internal compounding are more likely to be priced as superior businesses, given their success. A better approach is to find those businesses that exhibit competitive advantages but have yet to post stellar financial results. These rare situations can be a source of high total returns for the astute manager.