There are many elements of a high quality business, not all of which can be measured. The most notable is competitive advantage. However, there are some quantitative indicators of business quality. High quality businesses have high returns on equity which means that they can compound the business (and the wealth of shareholders) at high rates year after year. They have low levels of debt which provide a buffer against rising interest rates and enables cash flow to be used to grow the business. It is also handy to know that the business generates enough cash to cover its interest-bearing debt….
There are many elements of a high quality business, not all of which can be measured. The most notable is competitive advantage. However, there are some quantitative indicators of business quality.
High quality businesses have high returns on equity which means that they can compound the business (and the wealth of shareholders) at high rates year after year.
They have low levels of debt which provide a buffer against rising interest rates and enables cash flow to be used to grow the business. It is also handy to know that the business generates enough cash to cover its interest-bearing debt.
Here are four mid-cap companies that are good quality businesses by virtue of high returns on equity, low debt levels, and the ability to cover interest payments with cash many times over.
A2 Milk Company Ltd (ASX: A2M)
The a2 milk company markets, distributes, exports and sells milk and infant formula. The company has trading activities in Australia, New Zealand, China, USA and UK. Its products are free of the A1 protein that is usually present in cows’ milk, and include only the A2 protein which the company says does not cause discomfort for those who have difficulty digesting ordinary milk. The company reported a return on equity of 37% last year, and holds more cash than liabilities.
Altium Limited (ASX: ALU)
Altium provides PC-based electronics design software for engineers who design printed circuit boards. Printed circuit boards support and connect the electronic components of a product and are the foundation of most electronic products today. Last year Altium reported a return on equity of just over 20%, as well as no debt.
Fisher & Paykel Healthcare Corp Ltd (ASX: FPH)
Fisher & Paykel design, manufacture and market medical device products and systems for use in respiratory care, acute care and the treatment of obstructive sleep apnoea. The company provides products for hospitals which include adult and infant respiratory and surgical equipment. The company also provides sleep apnoea equipment for the home.
In 2017 Fisher & Paykel reported total interest bearing debt of $36.5 million compared to shareholders equity of $604.2 million. It also reported a total return on equity of 26%.
Bellamy’s Australia Limited. (ASX: BAL)
Bellamy’s offer a range of organic food and formula products for babies, toddlers and young children. The company has over 30 products in its range from birth to early childhood. In 2017 Bellamy’s reported no debt, and a return on equity of 29%.
Here are four mid-cap companies with very little or no debt, and high rates of return on equity. This gives a good indication as to the quality of the business. I’d consider buying these companies at a reasonable price and holding them for a number of years.
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Motley Fool contributor Stewart Vella has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of A2 Milk and Altium. 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 Scott Phillips.