20 Value Stocks Scoring Highest for Long-term Returns on Invested Capital

Wednesday’s stock market action was particularly harsh for some popular tech stocks that had been performing well. Over the past three weeks, there has been a noticeable shift towards value-oriented stocks and away from Big Tech. If this trend persists, it might be worth considering value stocks that are screened for quality.

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The group of stocks known as the Magnificent Seven, which includes Microsoft Corp. (MSFT), Apple Inc. (AAPL), Nvidia Corp. (NVDA), Amazon.com Inc. (AMZN), Meta Platforms Inc. (META), Alphabet Inc. (GOOGL), and Tesla Inc. (TSLA), collectively saw their market capitalization drop by $1.7 billion over two weeks ending Wednesday. These stocks make up 31% of the SPDR S&P 500 ETF Trust (SPY).

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Value stocks are generally considered to be those trading at relatively low prices compared to their expected earnings per share or book value and/or belong to companies expected to grow at a slower pace.

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Joseph Adniolfi explored what is being termed the "Great Rotation" into value and small-cap stocks. This trend follows many years where stocks of rapidly growing companies, especially in the information technology sector, dominated market action. Adniolfi outlined three factors that could influence the duration of this trend.

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To frame the discussion about value stocks, let’s review the performance of several broad stock indexes up to Wednesday. The returns, shown from the end of 2021, highlight the pattern of decline and recovery, particularly for growth-oriented stocks, in 2022 and 2023. This shift underscores investors’ growing interest in value stocks.

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Screening the Russell 1000 for Long-Term Quality

The Russell 1000 Index (RUI) comprises the 1,000 largest companies in the Russell 3000 Index (RUA), which represents about 98% of the U.S. market for publicly traded common stocks. The Russell 1000 Value Index (RLV) includes 872 companies with relatively low price-to-book ratios, lower growth estimates for the next two years, and lower sales growth over the past five years. You can find more details on FTSE Russell’s selection and weighting methodology for the index here.

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There are various methods to screen stocks. This time, instead of looking at future estimates, we focus on returns on invested capital (ROIC). A company’s ROIC is its profit divided by the sum of the carrying value of its common stock, preferred stock, long-term debt, and capitalized lease obligations. ROIC is an annualized figure that provides insight into how efficiently a company's management team allocates investors’ money. However, it is not a perfect measure, as some industries are more capital-intensive than others.

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Consider that the carrying value of a company’s stock may be much lower than its current market value. If a company issued most of its shares many years ago at a much lower price than today’s price, its ROIC will be higher. Conversely, if a company has recently issued many shares at high prices, its ROIC will be lower. If a company has low debt, its ROIC is higher. Conversely, if it needs to increase borrowings, its ROIC will decrease.

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To screen the Russell 1000 Value Index, we examined the companies’ average ROIC over the past 10 years, as calculated by FactSet. FactSet calculates ROIC for the past four quarters each quarter. To determine the 10-year average ROIC, we looked at the data for the most recent quarter, then the previous four quarters, and so on. If FactSet lacked the necessary data for the most recent quarter, we used the previous quarter’s data and went back four quarters from there. Thus, the data for the 10-year averages goes back 40 or 41 quarters.

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After identifying companies with the highest 10-year average ROIC, we refined the list to include only those whose three-year average ROIC was higher than their 10-year averages.

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Here are the 20 components of the Russell 1000 Index with the highest 10-year ROIC, which have also shown recent improvement based on their three-year ROIC:

VeriSign (VRSN) typically ranks high on such lists. The company holds a dominant market position in internet domain registry services, a business that is not capital-intensive.

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These companies have generally performed well, based on 10-year total returns with dividends reinvested. Sixteen out of the 20 have beaten the S&P 500’s 230% 10-year return. Ten have outperformed the Russell 1000 Growth Index’s 10-year return of 338%. Nineteen have exceeded the Russell 1000 Value Index’s 10-year return of 124%.

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Remember, a stock screen is not a guarantee. It is a useful starting point for your own research as you form an opinion about how well a company is likely to remain competitive over the next decade or more.

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