Here's the next ASX share I'm going to buy

It's a high bar to make it into my portfolio but, for me, this ASX-listed company is running rings around the competition.

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A woman stares directly ahead wearing diamond earrings, diamond necklace and diamond bracelet. as the Lovisa share price rises

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Building an elite portfolio is similar to assembling an A-grade sports team. You want to be highly selective with the ASX shares drafted into your squad, picking the highest achievers among listed Australian companies.

However, unlike many professional sports, the investing world has no salary caps. That means we are free to sign all the top players to our portfolio unabated.

Imagine a basketball team with LeBron James, Stephen Curry, Kevin Durant, and Nikola Jokic all on the same team — daresay, almost unbeatable, I would think. I believe it's aspirational to create our own dream team inside of our portfolios.

In saying that, there is one ASX share displaying sensational quality that could be my next draft pick.

Wonderful company at a fair price

A company must demonstrate it is a cut above the rest before making it into my portfolio. As I see it, there is no room for 'average' ASX shares as a stockpicker.

If the average is acceptable, it would conceivably make more sense to stick with an exchange-traded fund (ETF) that tracks the S&P/ASX 200 Index (ASX: XJO) and call it a day. Lovisa Holdings Ltd (ASX: LOV) is an ASX-listed company that has proven to be far beyond average, in my opinion.

Trading on a price-to-earnings (P/E) ratio of approximately 33 times earnings, some might baulk at the premium valuation of this internationally operating jewellery retailer. Although, I would argue the premium valuation is warranted based on its superior execution.

Here are a few traits of Lovisa that catch my attention:

  • It boasts a gross margin of roughly 80% (It makes its products for 20 cents and sells them for $1
  • Return on capital employed (ROCE) of 34% in the last year, lifting from 30% three years ago; and
  • Sells small-ticket consumer non-durables (cheap jewellery doesn't last and goes out of fashion, leading to repeat purchases)

These are the makings of what I would consider a resilient business that can reinvest its earnings at an attractive return.

The runway is long for this ASX share

Now, what about the future? Great returns in the past are all well and good, but the forward potential is what we're counting on.

Fortunately, there is a good chance Lovisa could continue to reinvest its profits at a high return for many years still to come. The reason for this I believe comes down to the undeveloped presence remaining in other countries.

For example, the company's most mature market (Australia) counted 163 stores at the end of the first half of FY23. Working on an Australian population of 25 million equates to roughly 6.5 stores for every million Australians.

Meanwhile, Lovisa reached 155 stores in the US in the first half. This is about 0.5 stores for every million people in the United States. In my mind, that would suggest the number of Lovisa stores in the US could increase by 13-fold before reaching the same level of maturity as its Australian market.

On top of this, the company is operating in another 30 or so other countries.

What I would keep an eye on

Much like a star athlete has occasional poor performances, Lovisa could have sporadically disappointing results. I think it is important not to kick a typically exceptional performer out of the team on a single game/set of numbers.

Instead, I would track the general trend over time for Lovisa in three core metrics to ensure its standards aren't dropping. These being:

  • Gross margin — falling gross margin could indicate tougher competition
  • Store growth — expansion helps Lovisa reach a larger market
  • Return on capital employed — shows whether management is allocating capital productively

If Lovisa can get the basics right consistently, this ASX share will quickly find its way onto my investment roster.

Motley Fool contributor Mitchell Lawler has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Lovisa. The Motley Fool Australia has recommended Lovisa. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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