Cracking the Corporate Investment Code

Written by Jordan Waldrep, CFA , Bank OZK Chief Investment Officer

When we invest in a company’s equity or debt for the long term, we are putting our client’s capital at risk in an operating business. We don’t know what that company will look like in the future, but we can look for certain features in companies that we believe will have the best chance of success over the long term. In making that choice, we are hopeful that successful operations will translate into greater profitability and increased returns for our clients. There are five things that we want to see in an ideal investment.

1. Return on Invested Capital is a measure of the quality of the underlying business and its ability to generate cash. When it is high, the business generates more cash. This measure allows us to evaluate operating businesses across industries and sectors.
2. High Barriers to Entry mean a business can sustain high returns, and it’s hard for competition to force the business to lower profitability. Competition is the friend of the consumer, but not so much the shareholder.
3. Good Opportunities to Reinvest in the business. When a company has great returns and generates extra cash, they will usually reinvest in the business. Shareholders want that reinvestment to show up on the financial statements as a growing capital base with growing returns.?
4. Strong, Disciplined Management is the primary steward of investors’ capital, so they must make great decisions on how to deploy investors’ money.?
5. Low Leverage is preferred. Debt is how a business leverages its operations to appear more profitable for equity holders. Some level of debt makes sense for most companies, but a lower level of debt is better. Low leverage is “dry powder” for future opportunities.? Too many companies use debt to try to make their stock look good.?

Ideally, we want a portfolio of high-quality names with great long-run growth opportunities that are positioned to deliver more stable (i.e., less volatile) returns with smaller downside risk than the overall market. Whether we are talking about a stock or a bond, we believe that a company with these characteristics will be better positioned for long-term success and have a better chance of delivering strong returns.

Achieving greater wealth starts here. Connect with one of our wealth advisors to get started: https://www.ozk.com/trust-wealth/.

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