What are we looking for?
Companies with pricing power. Warren Buffett has been successful in large part because he has been able to identify companies that are able to increase the price of what they sell without losing demand from customers. The best companies do this with minimal need for capital investment.
How we did it
We looked for Canadian and U.S. companies that have:
- An average annual return on invested capital (ROIC) above 12 per cent. Invested capital includes both debt and equity, so ROIC is a good measure of how good a company is at producing profits from the capital at its disposal. Mr. Buffett has repeatedly mentioned the 12 per cent figure as a key hurdle.
- Growth in invested capital below the rate of inflation, which we will assume is 2 per cent.
- Annual revenue growth of 2 per cent or greater.
What did we find?
Blue-chip large-cap stocks make up much of the accompanying list. Most have significant brand value and intangible assets. Their pricing power provides strong assurance that these stocks should do fine even if inflation were to roar. But because of their quality, these stocks aren't cheap. On average, they sell for 19 times earnings.
Our list features a lot of variety.
The Buckle is a casual-apparel retailer based in Buffett's home state of Nebraska. It has the highest ROIC on the list and grows its top line like clockwork.
Home Depot is the go-to destination for anything related to home improvement.
Meanwhile, Limited Brands – the parent company of Victoria's Secret, Bath & Body Works, and La Senza – provides a fine example of a company with unexpected pricing power.
Alex Rasmussen is Co-President of Investors of Tomorrow (IOT), a charity devoted to teaching students responsible investing, and a student at the University of Western Ontario.