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3 Cheap Stocks With High Returns on Capital

For stock tickers, few measures separate winners from losers like return on invested capital. Calculating ROIC is simple enough. To do so, divide the amount of profit a company generated over the past year by the value of the stuff it owns, plus the amount it owes (in other words, equity plus debt).

The profits at the top of this fraction speak of the company’s ability to drive sales without slashing prices and to keep corporate overhead and manufacturing costs low. Total capital, on the bottom of the fraction, shows whether a company can fund growth without over-borrowing, and whether it can generate new business with the equipment it already owns, rather than constantly spending on new gear.

Companies that are able to earn a lot while using little end up with the fattest returns on invested capital. Averages vary sharply by industry, but in general, investors should favor companies whose ROICs are safely into double digits — provided their stock ticker prices seem reasonable. (Be wary of unrealistically high ROICs, though, since they might be due to windfall profits that won’t recur in coming years.)

Below are three companies with modest price/earnings ratios and ROICs of at least triple the current 7% median for the S&P 500 index.

Hillenbrand

ROIC: 34%

I’ve never quite understood why a coffin should cost two or three times as much as a reclining chair, even though comfort and durability are surely more important in the latter. But high prices and reluctance among the bereaved to shop around for a better deal make for superb margins in the coffin business. Hillenbrand (HI), whose Batesville-brand caskets are the U.S. sales leader, turns 24 cents of each sales dollar into operating profit, nearly three times as much as the median S&P 500 company. The business is resistant but not immune to economic slowdowns. Some strapped customers have traded down from Hillenbrand’s hardwoods to its veneers, while others have spent even less by opting for one of its cremation urns. Also, death isn’t exactly a growth market at the moment, thanks to steady medical advances. Still, sales for Hillenbrand are seen falling just 4% in its fiscal year ending Sept. 30, with growth resuming next year. Shares sell for less than 12 times earnings and offer a lovely dividend yield of 4%.

Weight Watchers

ROIC: 32%

According to ConsumerSearch.com, which amalgamates product and service reviews from other sources, Weight Watchers (WTW) is considered the best weight-loss program. Participants track “points” they accumulate at mealtime and expend at the gym. The company sells its own food, but shows dieters how to tally points from the nutrition labels of any food. With consumers keen on cutting monthly bills, Weight Watchers sales are expected to fall 10% this year. But margins remain stellar, long-term growth prospects are decent and shares sell for just 11 times earnings and pay a 2.4% dividend.

Gymboree

ROIC: 29%

Once a play center for children, Gymboree (GYMB) now sells clothing for newborns to 12-year-olds out of more than 900 stores. Analysts say its back-to-school wares are “fashion-appropriate.” When I was 10 that meant that my Sears corduroys didn’t have too many grass stains and my shirt was right-side-out. Now it means young Jacob and Emma have prefaded jeans, ironic-message T-shirts and camouflage sunglasses. Sales and profits for Gymboree are growing this year, the company has no net debt and its shares sell for just 13 times earnings. Management should think about accessorizing with a dividend.

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