3 signs you’ve found a great company

One of the cool things about being a small investor is the absolute discretion we have when it comes to finding companies.

It’s our money after all, so we can be exceptionally picky and hold out to find the next Domino’s Pizza Enterprises Ltd (ASX: DMP) or CSL Limited (ASX: CSL).

Here are three signs I look for which can signal a great company;

1. The company drives repeat business or recurring revenues

I don’t eat much pizza, but every year Domino’s still manages to solicit slices of my hard-earned money.

Pizza, by the way, is probably the greatest sharing food ever invented. Moving house? Domino’s. Team lunch? Domino’s. Watching rugby with mates? Domino’s.

The company manages to harvest people like me for repeat business because it brilliantly meets my needs in a highly efficient and consistent manner.

Another quite different example is Emerchants Ltd (ASX: EML). Emerchants operates gift and reward cards for businesses including malls and gambling outfits. Customers to these operators repeatedly use the cards, loading and redeeming credit which Emerchants processes through its own system.

2. The company consistently produces strong returns

It takes something special in a company to produce above average returns. This can be measured various ways, but one of my favourites is the return on equity (ROE) measure.

The average return on equity for listed U.S. companies in 2015 was about 10%, but I like to bump that up to about 25% as the measure of a great company.

Producing consistently strong returns suggest that a company is a superior operator, or has a significant competitive advantage which will help it dominate its market.

A clear example is healthcare star CSL Limited (ASX: CSL), which produces returns on equity of almost 50%. Although returns on equity can be inflated by taking on heaps of debt, in my view CSL’s current debt levels are reasonable.

3. Still… bugger all debt is usually best

You’ve heard this before, but having a ‘strong balance sheet’ is an investing platitude for good reason.

Young or old, big or small, a company with conservative or very little debt is far more favourable than one with a debt burden.

Young, growing companies often don’t have the spare cash to service debt, while large, mature companies can still get into trouble if their debt pile grows and economic conditions shift.

Santos Ltd (ASX: STO) is a perfect example, having loaded up on debt to fund capital expenditure then getting caught out by falling energy prices and having to offload assets and raise equity.

Maintaining very little debt leaves room for growth and to take advantage of attractive acquisition opportunities – another sign of a great company.

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Motley Fool contributor Regan Pearson has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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