Article by Robert Currie for the Times & Transcript February 28, 2019

“A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns.”

Warren Buffet, 2007 Letter to Shareholders

One of the many pillars of fundamental investing is finding companies that have created value over time. But what does it mean for a company to “create value?” 

When a company builds a plant, buys trucks, or acquires another company, they are choosing to invest cash into assets they assume will create more value than the cost of that cash. For example, imagine you borrowed $10 million at an interest rate of 4% to buy a $10 million warehouse that you would lease. The only way this creates value is if the lease generates more than enough income to cover the cost of borrowing, which in this case is 4%. This is often misunderstood but directly relates to a business’ ability to grow over time.

Each year companies decide how much cash (or capital) they will set aside for dividends, share buybacks, acquisitions, and investments (like buildings, equipment, intellectual property, etc…). Outside of maintenance investment, companies invest in order to grow or reduce costs. This can vary dramatically by industry, which makes it incredibly important to understand. The variability is why a grocery company, for example, rarely offers the type of shareholder return a successful tech company might. For a grocery company to grow, they need to allocate capital to building massive stores, filling them with inventory, expanding warehouses, and buying trucks. On the other hand, many technology companies have the ability to continuously generate incremental income with very little additional investment.

These contrasting examples have very different risk profiles but the mental exercise is still useful. Think of the income a company generates as the numerator and the investment it takes to generate it as the denominator. This gives you the company’s return on invested capital (ROIC). Companies that require less investment to growearnings (like a tech company) would typically have a much higher ROIC than grocers or other capital-intensive businesses. The higher the ROIC, the more value that is created. How does it create more value? Higher ROIC usually translates into higher earnings per share (EPS) growth over the long-run because it takes less investment (dominator) to grow earnings (numerator). This leaves more cash to return to shareholders or continue investing in the business.

As I already alluded to, risk plays a very important part in identifying good investment candidates as well. To Buffet’s point, because social media companies take very little investment to create, companies like Facebook and Twitter have an incredibly large army at their door trying to infiltrate their moat. On the other hand, it would take billions of dollars over several years to replicate the store footprint of Loblaw, Canada’s largest grocer. Expected returns need to compensate you for the risk you’re taking on. But that’s for another article another day. You can actually use this same logic for companies with similar risk profiles to see who has created more value over time.

There are three major public grocers in Canada: Loblaw (L: TSX), Empire (EMP.A: TSX), and Metro (MRU: TSX). Each company has invested a large amount of capital building their network and supply chain over several years. Given Empire is in a bit of an atypical season right now, let’s focus on Metro and Loblaw. Metro has been growing revenue slower than Loblaw over the past several years, however, Loblaw has invested relatively more capital with the acquisition of Shoppers and simply investing more heavily in their network. In theory, Metro’s higher ROIC should result in them having more cash left over after maintenance investments to pay down debt, buy back shares, or invest in their network. This is exactly what we see. Even after the acquisition of Jean Coutu in late 2018, Metro was able to reduce its share count by 25% and grow its EPS by 125% since 2008, taking on only modest incremental debt. Loblaw’s share dilution from investments have resulted in comparatively less EPS growth of ~90% over the same period. Furthermore, Metro has grown its dividend per share by 300% while Loblaw’s only grew by 40%. The result: Metro’s stock outperformed Loblaw’s significantly over this period.

This is not a hard and fast rule and doesn’t mean one will outperform the other going forward. It’s also not the only reason it outperformed, but it is certainly one reason, and one worth monitoring and comparing when looking for the right investment.

Robert Currie is an Investment Analyst with Louisbourg Investments Inc. Comments or questions may be submitted to This email address is being protected from spambots. You need JavaScript enabled to view it., or he may be reached at 386-4643.