In January 2003, the ASX All Ordinaries Price Index was at 2935 with a total domestic equities market capitalisation of $664 billion. The S&P/ASX 200 Price Index was at 2957.

At the end of October 2018, the ASX All Ords was at 5913, with a total market cap of $1.89 trillion. The S&P/ASX 200 was at 5830.

That represents a total return in the proximity of 100% – a doubling of your money over that time. Investors could access those returns through electronic traded funds that match the various ASX indexes. For example, the ASX200 is matched by the iShares S&P/ASX 200 ETF (ISHAUS200/ETF (ASX: IOZ)) and the ASX300 is matched by the Vanguard Australian Shares Index (V300AEQ/ETF (ASX: VAS)).

One of the major benefits of an ETF that match various indexes includes easy diversification, very low fees, and average returns with little effort required. However, there remains a large behavioural component in accessing market returns, even when buying ETFs that match the market index. Accessing market returns, for example, requires one to buy the index and hold it. Sometimes, this is easier said than done.

The Behaviour Gap

Fascinating research conducted by famed value investor Joel Greenblatt shows that the average investor can dramatically underperform the fund or index in which they are invested. In his book "The Big Secret for the Small Investor", Greenblatt reports that the best performing hedge fund for the ten years from 2000 to 2010 returned an annualised 18% per year over that time. Over that time the market was relatively flat. However, the average dollar-weighted return for investors in that fund was -11%. That is, investors on average underperformed the fund in which they were invested by 29% per year.

This phenomenon is known as the behaviour gap. The reason for the behaviour gap is simple. When the fund or an index does well, investors put money in. When the fund or index does poorly, investors take their money out. It's the old 'buy high, sell low' mistake.

Foolish Takeaway

The solution is, of course, to buy and hold through the variability of performance that is inevitable. Although, this can be difficult. Even some of the ASX's best companies have suffered major downturns. Cochlear Limited (ASX: COH) has recently been down over 25%, as has Corporate Travel Management Ltd (ASX: CTD) and Afterpay Touch Group Ltd (ASX: APT), while CSL Limited (ASX: CSL) is down over 20%.

The post The behaviour gap: Why many investors don't beat the share market appeared first on The Motley Fool Australia.

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Many prominent investors label themselves as 'contrarian' investors. Names such as Warren Buffett, Howard Marks, and Bill Miller have become synonymous with the term.

But what is contrarian investing?

In his book 'Contrarian Investment Strategies' David Dreman explains that contrarian investing is about buying those companies that are so unloved by the market that the likelihood of a positive surprise (and subsequent increase in the share price) is far higher than with other companies. In the long run, Dreman argues that this means that the returns on contrarian strategies are likely to be higher than the market return.

Dreman explains that the limitations of investors in forecasting the future earnings of companies means that surprises are inevitable. The basic premise of contrarian investment strategies is that when one buys companies that are priced as if they are going out of business, forecasting mistakes are most likely to be those that underestimate future earnings.

How do you find a contrarian investment?

According to Dreman, the best way to measure the extent to which a company is out of favour with the market is to use the price-to-earnings, price-to-cashflow, or price-to-book ratios. Investors should buy solid companies with low ratios. These could be companies with low absolute ratio values (i.e., the lowest price-to-earnings ratio of all companies) or low relative ratio values (e.g., the lowest price-to-earnings ratio of all companies in a particular industry).

Tobias Carlisle (in his book The Acquirers Multiple), Joel Greenblatt (in his book The Little Book that Beats the Market) and Dreman himself (in his book Contrarian Investment Strategies) have all reported tests of versions of this contrarian investment strategy with strong returns.

At any given time, investors will find companies that are out of favour with the market.

For example, companies with low price-to-earnings ratios on the ASX currently include:

• Retail Food Group Limited (ASX: RFG),
• The Reject Shop Ltd (ASX: TRS)
• Cash Converters International Ltd (ASX: CCV)

Companies with low price-to-book values include:

• Thorn Group Ltd (ASX: TGA)
• Shine Corporate Ltd (ASX: SHJ)
• United Overseas Australia Limited (ASX: UOS)

Lastly, those with low price-to-cashflow include:

• Collection House Limited (ASX: CLH)
• Qantas Airways Limited (ASX: QAN)
• Shaver Shop Group Ltd (ASX: SSG)
• Air New Zealand Limited (ASX: AIZ)

Foolish Takeaway

Contrarian investment strategies can be profitable because investors systematically underestimate the potential for upside surprises. A basket of low price-to-earnings, low price-to-book value, or low price-to-cashflow companies have been shown to produce strong returns over the long run.

The post Contrarian Investing and the ASX appeared first on The Motley Fool Australia.

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Investing for income isn't only about buying the highest yielding stocks. Other considerations are also important. I prefer mature companies with a history of strong dividend payments, a high payout ratio, and enough growth to sustain increases in the dividend paid annually.

All else being equal, quality companies with no debt and high returns on equity are also preferable.

While it is difficult to find companies who meet all of the criteria outlined above, there are a few sectors which seem to tick many of the boxes, although not without some risk.

I'd be inclined to spread my investment across banking, Telstra and three strong companies with moderately high yields.

The big banks have taken a few hits recently, not the least of which have come from the royal commission. One might think seriously about their prospects for meaningful growth over the coming years.

Nonetheless, if Westpac Banking Corp (ASX: WBC) maintained its dividend at $1.88 per share, this would represent a yield of 6.6% at the current share price of $29.28.

Alternatively, Australia and New Zealand Banking Group (ASX: ANZ) would have a yield of 5.7% at the current share price of $27.87 if the dividend was maintained at $1.60 per share. Westpac and ANZ have payout ratios of 81% and 82% respectively, and both offer dividends that are fully franked.

While growth may be stilted, I think that there is sufficient strength in earnings with the banks to at least maintain the dividends over time. As an alternative to the big four banks, Money3 Corporation Limited (ASX: MNY) would yield a fully franked 4.7% on a forecast dividend of 9 cents per share, and may have more room for growth in earnings meaning that it also has more room to increase its dividend.

Telstra Corporation Ltd (ASX: TLS) has also taken a hit of late. Weakness in the mobile arm of the business and strong competition has investors less enthusiastic about its future earnings potential than they once were. As a consequence the share price has fallen dramatically – down to six year lows. Despite a recent cut to the dividend, Telstra offers a fully franked 7.7% at the current share price of $2.87. I think that there is enough earnings potential to sustain the current dividend, but even further small reductions would still offer attractive yield for investors.

Lastly, I think that there are a group of strong companies with yields that are attractive, given the quality of the businesses. APN Outdoor Group Ltd (ASX: APO) at 3.7%, DuluxGroup Limited (ASX: DLX) at 3.4% and Flight Centre Travel Group Ltd (ASX: FLT) at 2.7% are all worth a place in my portfolio.

While the yield may not be as high as that currently on offer from the banks, or even from traditional retailers like JB Hi-Fi Limited (ASX: JBH) or Kathmandu Holdings Ltd (ASX: KMD), the strength of these 3 companies combined with moderately high yield is compelling.

The post The dividend shares I'd buy for income right now appeared first on The Motley Fool Australia.

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Fortescue Metals Group Limited (ASX: FMG) is an Australian iron-ore company that owns and operates integrated operations spanning three mine sites in the Pilbara, the five berth Herb Elliott Port in Port Hedland and a heavy haul railway.

Shares of Fortescue currently trade at $4.30 – a decrease of one third over the previous twelve months. The 52 week high is $6.42, and the 52 week low is $4.24. With earnings per share of $0.871 in 2017, shares are currently trading at a price to earnings ratio of just under 5 based on 2017 earnings. Analysts have forecast earnings of $0.57 per share in 2018, a decrease of 34% on the previous 12 months. This puts the current share price at a price to earnings ratio of 7.6 based on forecasted 2018 earnings.

In the last 10 years, Fortescue has grown its book value at an annualised rate of 27.6%. The current price to book ratio is 1.05. Over the same period, Fortescue has grown earnings at an annualised rate of 10.9%, and its cash flow at 14.3%.

Over its last 5 financial reports Fortescue's return on invested capital has ranged from 5% to 22%, and has averaged 14%. This represents an average return over that period.

In 2017, Fortescue paid a fully franked dividend of $0.45.

So what are the shares worth?

According to its 2017 financial report, Fortescue held $5.65 billion in interest bearing debt, and $2.39 billion in cash and equivalents. At a current market cap of $13.26 billion, Fortescue's enterprise value is around $16.53 billion. With earnings before interest, tax, depreciation and amortisation (EBITDA) of 6.1 billion, the company's enterprise multiple is around 2.7. This tells me that the shares are extremely cheap at the current price.

A discounted cash flow model using only half the historical growth rate in book value as the growth rate for the next 10 years and then a 2% growth rate thereafter, capital expenditures equal to those in 2017, and a required return of 10% per year places the intrinsic value of the shares around $18.63 – far in excess of the current share price.  This is, of course, heavily dependent upon the growth rate and your required return, although I doubt that tinkering with any of the inputs would result in a price close to the current market price.

FOOLISH TAKEAWAY.

Based on the above, shares are probably worth a lot more than they currently are. Undoubtedly, Fortescue has some headwinds that it will need to push through – companies are rarely this cheap without some sort of obvious obstacle. However, in this case, the price is low enough for me and I'd be a buyer at the current price.

The post Fortescue Metals Group Limited: Are the shares a bargain? appeared first on The Motley Fool Australia.

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CSL Limited (ASX: CSL) develop and deliver innovative biotherapies and influenza vaccines.

Shares of CSL currently trade at around $158– an increase of 24% over the previous twelve months. The 52 week high is $167.66, and the 52 week low is $119.01. With earnings per share of $3.81 in 2017, shares are currently trading at a price to earnings ratio of 41.5 based on 2017 earnings. Analysts have forecasted earnings of $4.67 per share in 2018, an increase of 22% on the previous 12 months. This puts the current share price at a price to earnings ratio of 33.8 based on forecasted 2018 earnings.

In the last 10 years, CSL has grown its book value at an annualised rate of 6.6%. The current price to book ratio is over 17. Over the same period, CSL has grown earnings at an annualised rate of 13%, and its cash flow at 11.9%.

Over its last 5 financial reports, CSL's return on invested capital has ranged from 25.5% to 39.3%, and has averaged 33%. This represents a very strong return over that period.

In 2017, CSL paid an unfranked dividend of $2.025.

So what are the shares worth?

According to its 2017 financial report, CSL held $5.01 billion in interest bearing debt, and $1.1 billion in cash and equivalents. At a current market cap of $70.57 billion, CSL's enterprise value is around $744.85 billion. With earnings before interest, tax, depreciation and amortisation (EBITDA) of $2.51 billion, the company's enterprise multiple is around 29.7. An enterprise multiple of 10 would be a fair (or in this case, cheap) price to pay, and this would necessitate a market capitalisation of $21.18 billion, and a share price of around $47.00.

A discounted cash flow model using the historical growth rate in cash flow as the growth rate for the next 10 years and then a 2% growth rate thereafter, capital expenditures equal to those in 2017, and a required return of 10% per year places the intrinsic value of the shares around $80.00.  This is, of course, heavily dependent upon the growth rate and your required return. A required return of 15% would place the intrinsic value at $56.00. For CSL, however, the growth rate is also important. If you assume that the growth rate for the next ten years to be equal to its average return on invested capital – around 25% – the intrinsic value of the shares could be around $225 at a 10% rate of return, and $150 at a 15% return.

FOOLISH TAKEAWAY.

I'm not convinced that a 25% growth rate is a prudent assumption. However, if it was then shares are looking fairly priced. Based on the above, I'd be a little more conservative and say that shares are probably worth somewhere between $60 and $80. However, the calculation of intrinsic value is not an exact science. Given the historical growth in book value and returns on invested capital, I'd be happy to buy the shares at around $80, but I'm not holding my breath.

The post CSL Limited: Here's what I would pay for the shares appeared first on The Motley Fool Australia.

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Ramsay Health Care Limited (ASX: RHC) is a global hospital group operating 235 hospitals, day surgery centres, treatment facilities, rehabilitation and psychiatric units and a nursing college across Australia, France, the United Kingdom, Italy, Indonesia and Malaysia. It is one of the top five private hospital operators in the world.

Shares of Ramsay currently trade at $61.43 – a decrease of 11.5% over the previous twelve months. The 52 week high is $76.18, and the 52 week low is $61.06. With earnings per share of $2.36 in 2017, shares are currently trading at a price to earnings ratio of 26.1 based on 2017 earnings. Analysts have forecasted earnings of $2.86 per share in 2018, an increase of 21% on the previous 12 months. This puts the current share price at a price to earnings ratio of 21.4 based on forecasted 2018 earnings.

In the last 10 years, Ramsay has grown its book value at an annualised rate of 8.9%. The current price to book ratio is 5.5. Over the same period, Ramsay has grown earnings at an annualised rate of 16.3%, and its cash flow at 18.1%.

Over its last 5 financial reports, Ramsay's return on invested capital has ranged from 19.7% to 25.1%, and has averaged 21.8%. This represents a relatively strong return over that period.

In 2017, Ramsay paid a fully franked dividend of $1.345.

So what are the shares worth?

According to its 2017 financial report, Ramsay held $3.26 billion in interest bearing debt, and $419.5 million in cash and equivalents. At a current market cap of $12.55 billion, Ramsay's enterprise value is around $15.4 billion. With earnings before interest, tax, depreciation and amortisation (EBITDA) of $1.26 billion, the company's enterprise multiple is around 12.25. An enterprise multiple of 10 would be a fair to cheap price to pay, and this would necessitate a market capitalisation of around 9.7 billion, and a share price of $48.12.

A discounted cash flow model using the historical growth rate in book value as the growth rate for the next 10 years and then a 2% growth rate thereafter, capital expenditures equal to those in 2017, and a required return of 10% per year places the intrinsic value of the shares around $78.00.  This is, of course, heavily dependent upon the growth rate and your required return. A required return of 15% would place the intrinsic value at around $55.50.

FOOLISH TAKEAWAY.

Based on the above, and in consideration of the tailwinds in the form of an ageing population, shares are probably worth somewhere between $48.00 and $56.00, less any margin of safety that you desire. However, the calculation of intrinsic value is not an exact science and is dependent on many factors. Given the historical growth in book value and returns on invested capital, I'd be happy to buy the shares at around $50.00.

The post Ramsay Health Care Limited: What I'd pay for the shares appeared first on The Motley Fool Australia.

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Flight Centre Travel Group Ltd (ASX: FLT) provides travel retailing, wholesaling and corporate travel management services.

Shares of Flight Centre current trade at $56.86– an increase of 95% over the previous twelve months. The 52 week high is $59.30, and the 52 week low is $28.52. With earnings per share of $2.32 in 2017, shares are currently trading at a price to earnings ratio of 24.54 based on 2017 earnings. Analysts have forecasted earnings of $2.65 per share in 2018, an increase of 14.5% on the previous 12 months. This puts the current share price at a price to earnings ratio of 21.4 based on forecasted 2018 earnings.

In the last 10 years, Flight Centre has grown its book value at an annualised rate of 9.8%. The current price to book ratio is 4.05. Over the same period, Flight Centre has grown earnings at an annualised rate of 5.2%, and its cash flows have decreased at 3.5%.

Over its last 5 financial reports, Flight Centre's return on equity has ranged from 9.2% to 12.65%, and has averaged 10.95%. This represents only a moderate return over that period.

In 2017, Flight Centre paid a fully franked dividend of $1.39.

So what are the shares worth?

According to its 2017 financial report, Flight Centre held no interest bearing debt, and $1.28 billion in cash and equivalents. At a current market cap of $5.79 billion, Flight Centre's enterprise value is around $4.51 billion. With earnings before interest, tax, depreciation and amortisation (EBITDA) of $406.2 million, the company's enterprise multiple is around 11.1. An enterprise multiple of 10 would be a fair price to pay, and this would necessitate a market capitalisation of $5.34 billion, and a share price of $52.86.

A discounted cash flow model using the historical growth rate in book value as the growth rate for the next 10 years and then a 2% growth rate thereafter, capital expenditures equal to those in 2017, and a required return of 10% per year places the intrinsic value of the shares around $55.70.  This is, of course, heavily dependent upon the growth rate and your required return. A required return of 15% would place the intrinsic value at $39.67.

FOOLISH TAKEAWAY.

Based on the above, shares are probably worth somewhere between $40 and $50, less any margin of safety that you desire. However, the calculation of intrinsic value is not an exact science. Given the historical growth in book value and returns on invested capital, I'd be happy to buy the shares at around $50.

The post Flight Centre Travel Group Ltd: Here's what I think the shares are worth appeared first on The Motley Fool Australia.

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Small cap companies are able to grow quickly for several reasons. First, capturing meaningful increases in market share is easier when you are smaller. It is much easier to double market share from 5% to 10% than it is from 30% to 60%. Second, small cap companies in emerging industries typically face less competition for market share compared to larger cap companies operating in established industries. Third, fewer competitors means that companies can demand higher margins for their products or services until such time as meaningful competition is introduced and they have to start to compete on price.

There are many wonderful small cap companies growing at a rapid rate. Afterpay Touch (ASX: APT) is one example of a small cap company with high expectations for growth. However, you'll have to pay up for the privilege of owning the company at today's prices.

Here are 3 small cap companies that I believe are reasonably priced given their growth potential.

Money3 Corporation Limited (ASX: MNY)

Money3 Corporation provides financial services in the form of small cash loans, secured and unsecured personal loans, cheque cashing, and vehicle rental. Shares of Money3 currently trade at a Price to Earnings ratio of around 9.8. However, analysts are not forecasting much growth for 2018, if any at all, and is likely why shares are trading at reasonable multiples.

Codan Limited (ASX: CDA)

Codan is engaged in the development of electronic solutions for government, non-government, and consumer markets. Its businesses include radio communications, metal detection, mining automation, and defence electronics. The company current trades at a PE of 10.5. Analysts have forecast a decline in earnings per share for 2018 which may be why they are reasonably priced for a strong company.

Super Retail Group (ASX: SUL)

Retailing has been on the nose for some time now and as an industry offers some of the best value on the ASX. Super Retail Group own and operate a number of Australian retail brands including Rebel Sport, Supercheap Auto, Ray's, and Boating Camping and Fishing (BCF). Combined, Super Retail Group operates over 630 stores across Australia, New Zealand and China. Shares currently trade at a PE of around 9. Despite weak guidance, analysts are forecasting a very small increase in earnings per share in 2018.

Foolish takeaway

Small cap companies have room to grow and benefit from less competition which can help to maintain higher margins. Money3 Corp, Codan, and Super Retail Group look to be 3 small cap companies that are very reasonably priced and could still grow meaningfully from here.

The post 3 reasonably priced small cap stocks appeared first on The Motley Fool Australia.

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Great companies earn very high returns on invested capital. Such companies are fantastic wealth creators because they can take a dollar of earnings and turn it into significantly more than a dollar over time. In fact, over many years, companies who can compound at high rates of return can turn a dollar into many hundreds of dollars.

For example, a company that can earn a return of 20% annually will deliver a 6-fold return over 10 years, and a 15-fold return over 15 years.

Investors can be very well served by holding shares in companies who compound earnings at high rates over many years. However, a large proportion of companies choose to pay out a meaningful percentage of their earnings to shareholders as dividends. While this is good for shareholders in some circumstances, it can also be detrimental if shareholders are unable to redeploy that capital at higher rates of return.

If a company can earn a return of 20% per annum most shareholders would be better off if the company kept its earnings and compounded it, rather than paying it out as a dividend.

Here are four companies with high returns and that pay no dividends.

A2 Milk Company Ltd (ASX: A2M)

The A2 milk company markets, distributes, exports and sells milk and infant formula that is free of the a1 protein that is usually present in cows' milk. The company earns a very high return on equity, and hasn't paid a dividend since listing on the ASX three years ago. Analysts are not forecasting a dividend payment for 2018.

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 consistently earned very high rates of return over the last four years. It did not pay a dividend last year, but did pay out 26% and 31% of its earnings in 2015 and 2016 respectively. Analysts have forecast a dividend of around 2 cents per share in 2018, which is a forecast payout ratio of only 5%.

Bingo Industries Ltd (ASX: BIN)

Bingo provides end-to-end environmental and waste management solutions across the waste management supply chain. The company has not paid a dividend in the two years that it has been listed on the ASX, and has compounded shareholders equity at high rates. However, analysts have forecast a dividend of 5 cents per share in 2018, with a payout ratio of around 40%.

Foolish takeaway

Shareholders can benefit when companies pay no dividends and instead retain earnings to compound them at higher rates than shareholders could attain if the cash was returned to them. These four companies are reasonable options if investors are looking to benefit from compounding of their wealth over many years.

The post 3 companies I'd buy because they don't pay dividends appeared first on The Motley Fool Australia.

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Investors rarely get wonderful companies at cigar butt prices. Nonetheless, cigar butts can be extremely profitable investments. Those 'cigar butt' companies may not be the most wonderful companies on the ASX, but when average companies are available at bargain prices investors can benefit.

In February, to find companies currently trading at wonderful prices, I sorted ASX stocks over $300 million in market capitalisation by their Sonkin Ratio. The Sonkin Ratio is a robust version of the Price to Earnings ratio. The Sonkin Ratio is simply the Enterprise value of a company divided by its operating earnings adjusted for tax. It can be expressed as:

Sonkin Ratio = (Market capitalisation – Cash + Debt) / EBIT(1 – Tax rate)

The Sonkin Ratio is the multiple of tax-adjusted operating earnings an investor would pay for the stock. Or, how much an investor would have to pay for every dollar of operating earnings.

Here is a March update on 10 of the cheapest companies on the ASX and their Sonkin Ratios.

Gold Road Resources Ltd (ASX: GOR) – 2.98

Spotless Group Holdings Ltd (ASX: SPO) – 4.03

Nine Entertainment Co Holdings Ltd (ASX: NEC) – 4.57

Mount Gibson Iron Limited (ASX: MGX) – 4.95

Village Roadshow Ltd (ASX: VRL) – 5.49

Tribune Resources Ltd (ASX: TBR) – 6.49

Resolute Mining Limited (ASX: RSG) – 6.58

United Overseas Australia Limited (ASX: UOS) – 7.25

Seven West Media Ltd (ASX: SWM) – 8.00

Myer Holdings Ltd (ASX: MYR) – 8.06

Fortescue Metals Group Limited (ASX: FMG) – 8.2

Foolish Takeaway

These are 10 of the cheapest stocks on the ASX over a market capitalisation of $300 million. Of course, there are many and varied reasons for why they are cheap. Distinguishing between those that represent bargain prices, and those that are companies in terminal decline is the difficult part.

The post 10 of the cheapest shares on the ASX: March update appeared first on The Motley Fool Australia.

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Investing in companies with very high rates of return on shareholders' equity is a strong wealth creation strategy. Companies who can earn upwards of 20% returns per annum on every dollar of equity over many years can turn a small investment into a very large one.

It can be even better if that company has very low levels of debt so that earnings can be reinvested in the business at high rates of return, as opposed to using the cash to pay interest debts.

Here are three companies with really high returns on shareholders' equity, and minimal debt.

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.

Lovisa Holdings Ltd (ASX: LOV)

Lovisa is a jewellery retailer with over 300 stores across Australia, New Zealand, Singapore, Malaysia, South Africa, Spain, France, the USA and the United Kingdom and franchised stores in the Middle East and Vietnam. The company runs a vertically integrated business model, through which it develops, designs, sources and merchandises its Lovisa branded products. The Lovisa products are aimed at fashion conscious females aged 25-45.

Lovisa reported a return on equity of over 100% in 2017, and very high returns are forecast for the next three years.

OFX Group Ltd Fully Paid Ord. Shrs (ASX: OFX)

OFX Group offer international payment and foreign exchange services. Last year, it paid a dividend of 5.7 cents per share, a return of 3.7% at the current share price and a payout ratio of 71%. The company reported a return on equity of over 30% in 2017, with analysts forecasting similar rates of return over the next 3 years.

Foolish takeaway

For those with long time horizons, high rates of return on equity can turn small investments in strong companies into very large ones. Letting your dollars compound at very high rates of return over many years is a fantastic wealth creation strategy. The A2 Milk Company, Lovisa Holdings, and OFX Group are three companies with very high rates of return that I'd consider buying today.

The post 3 companies with great returns on equity appeared first on The Motley Fool Australia.

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There appears a general consensus among value investors that the market is generally overpriced. It has become difficult to find overwhelming value over recent years, and many value investors are holding larger than usual amounts of cash. Warren Buffett's Berkshire Hathaway Inc. Class A (NYSE: BRK.A) is a case in point, with over USD$100 billion in cash.

However, there may be one or two companies, at least relatively speaking, where the value proposition is reasonably strong.

Washington H. Soul Pattinson and Co. Ltd (ASX: SOL)

'Soul Patts' is a self-described 'investment house'. It holds a diverse portfolio of assets across a range of industries, including investments in natural resources, building materials, telecommunications, retail, agriculture and property. Some of the more well-known brands in which the company owns significant stakes are TPG Telecom Ltd (ASX: TPM), Australian Pharmaceutical Industries Ltd (ASX: API), and Brickworks Limited (ASX: BKW). Importantly, some of these large holdings for the company look reasonably 'cheap'. Any meaningful rebound in the share price of these companies should be reflected in the Soul Patts price.

The company has a strong return on equity, and currently trades at around 1.3 times book value.

Macquarie Atlas Roads Limited (ASX: MQA)

Macquarie Atlas Roads is another 'boring', stable business that lends itself to reasonable estimations of value. The company owns and operates toll roads, bridges and tunnels in France, the United States and Germany. The company invests in global infrastructure assets that generate stable cash flows and offer potentially resilient long-term performance through economic cycles.

The company maintains a good return on invested capital, and it currently trades at 1.8 times book value.

Fortescue Metals Group Limited (ASX: FMG)

Fortescue has looked a little troubled of late. Volatile iron ore prices and decreasing demand for its lower quality iron ore have dented profits and hurt the share price over the last few years. However, when investors start to extrapolate such movements into the future the company can become undervalued.

Fortescue is currently trading at a P/E ratio of around 7.2, and at less than 1.2 times book value.

Foolish Takeaway

There may be some pockets of value around for those who desire boring business and long time horizon. I think that Washington H. Soul Pattinson, Macquarie Atlas Roads, and Fortescue Metals offer three such opportunities.

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Forecasting is a notoriously difficult task. It is almost impossible to know with certainty what the future of any given business will be.

As such, value investors typically seek to buy businesses where the range of possible future outcomes means that there is significantly greater upside potential for the share price than downside potential. That is, the price that you pay has enough pessimism built in that even a slight reversal of fortunes will pay off.

One area of particular pessimism has been traditional bricks-and-mortar retail. The threat of Amazon Inc and Australian businesses such as Kogan.com Ltd (ASX: KGN) has seen pessimism take over. While it may be justified, the real question is whether there is sufficient pessimism built into the price of traditional retailers that the potential upside is far greater than the potential downside.

I am inclined to believe so. Here are three small cap retailers that I'd buy today on their upside potential.

Adairs Ltd (ASX: ADH)

Adairs is a retailer of manchester and homewares. The company has over 160 stores across Australia in five physical store formats, comprising Adairs, Adairs Homemaker, Adairs Kids, UHR and Adairs Outlets. Adairs currently trades at a price to earrings multiple (PE) of 15.5.

Nick Scali Limited (ASX: NCK)

Nick Scali retails and imports household furniture and accessories including lounges, dining chairs, dining and coffee tables, cabinets, rugs, and entertainment units. The company currently trades at a PE of 15.

Super Retail Group Ltd (ASX: SUL)

Super Retail Group own and operate a number of Australian retail brands including Rebel Sport, Supercheap Auto, Ray's, and Boating Camping and Fishing (BCF). Combined, Super Retail Group operates over 630 stores across Australia, New Zealand and China. Shares trade at a PE of 8.6.

Foolish takeaway

Certainty is impossible in investing. Stacking the odds in your favour is therefore very important. Adairs, Nick Scali, and Super Retail Group are businesses that I believe can stack the odds in your favour at today's share prices.

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There are a limited number of ways a company can use the cash that it generates.

First, it can reinvest it back in the business in order to grow the business. This is a god idea if each dollar reinvested can return meaningfully more than one dollar in value for shareholders.

Second, a company can pay down its debt. This is a good idea if the interest rate on its debt is higher than the company could expect to get by reinvesting the money in the business, or if debt is becoming too high.

Third, the company can use its cash to acquire other, complementary businesses. This is a good idea if there are genuine synergies between the businesses that mean the return on the cash used to acquire other businesses is beneficial for shareholders.

Lastly, a company can return cash to shareholders if it cannot use it in a manner that generates sufficient returns. As such, small cap companies who are in growth phases might generally be dissuaded from paying out large percentages of their earnings to shareholders. However, this is not always the case.

Here are three quality small-cap companies, which have the cash to pay a good dividend to shareholders.

Servcorp Limited (ASX: SRV)

Servcorp provides executive services and virtual offices, as well as IT, communication and secretarial services worldwide. Servcorp paid a dividend of 26 cents in 2017 at a payout ratio of 63%. At the current share price, that represents a return of 5.4%. Analysts have forecast a dividend of 26 cents again in 2018.

OFX Group Ltd (ASX: OFX)

OFX Group offer international payment and foreign exchange services. Last year, it paid a dividend of 5.7 cents per share, a return of 3.7% at the current share price and a payout ratio of 71%. Analysts have forecast a dividend of 6 cents in 2018, a return of 3.9% if you buy the shares today.

APN Outdoor Group Ltd (ASX: APO)

APN Outdoor is an outdoor advertising company that operates in Australia and New Zealand. It offers advertising via digital and static billboards, as well as transit, rail, and airport advertising. Its 2017 dividend was 19.2 cents, representing a 4.6% return at the current share price. To achieve this, its payout ratio was 64%. Analysts have forecast a dividend of approximately 19 cents again in 2018.

Foolish takeaway

Small caps don't always retain their earnings for the purposes of growth. Servcorp, OFX Group and APN Outdoor are small cap companies that earn good cash profits and can pay a good percentage of these out to shareholders.

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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%.

Foolish takeaway

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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As companies get bigger, outsized growth in earnings becomes more difficult. However, companies with large competitive advantages can continue to perform well despite their size.

The S&P 500 shot up almost 20% in 2017 buoyed by large gains in some of the largest companies including Apple Inc. (NASDAQ: AAPL), Alphabet Inc (NASDAQ: GOOGL), Facebook, Inc (NASDAQ: FB), Amazon.com, Inc (NASDAQ: AMZN) and Netflix, Inc (NASDAQ: NFLX).

In contrast, the ASX 200 returned 7% in 2017 on the bank of declines in the share prices of large caps such as National Australia Bank Ltd. (ASX: NAB), Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia New Zealand Banking Group (ASX: ANZ) and Telstra Corporation Ltd. (ASX: TLS).

Nonetheless, there are large cap companies on the ASX with competitive advantages that can sustain outsized earnings growth in 2018. Here are three that I'd consider buying today.

CSL Limited (ASX: CSL)

CSL is an international biopharmaceutical company that is engaged in the research, development, manufacture, and marketing of vaccines and blood plasma protein biotherapies for the prevention and treatment of rare and serious medical conditions.

CSL makes up approximately 3.8% of the ASX 200 market-cap weighted index. Analysts have forecast growth in earnings per share of 19% in the current financial year, and over 50% in the next 3 years.

REA Group Limited (ASX: REA)

REA Group is a digital advertising company that operates residential, commercial, and share property websites including classifieds and advertising. Its websites include realestate.com.au, realcommercial.com.au, flatmates.com.au, iProperty.com, and myfun.com.

REA Group makes up approximately 0.6% of the ASX 200 weighted by market cap. Analysts have forecast growth in earnings per share of 24% at the end of the current financial year and by a massive 72% at the end of the 2020 financial year.

Sydney Airport Holdings Pty Ltd (ASX: SYD)

Sydney Airport Holdings owns and operates Sydney Airport. The company makes up approximately 0.88% of the ASX 200 weighted by market cap. Analysts have forecast a 12.5% growth in earnings per share in the 12 months to June 2018, and 37.5% through to June 2020.

Foolish takeaway

Outsized growth is possible for large cap companies where there exists a strong competitive advantage. CSL Limited, REA Group and Sydney Airport Holdings have such advantages and are forecast to deliver strong growth over the next 12-36 months.

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Compounding is a wonderful wealth builder. Even small positions in wonderful companies can become meaningful wealth builders when those companies earn high rates of return and are given a long period of time.

Here are three small cap companies with high rates of return on equity, low levels of debt, alongside room for exponential growth over many years.

IDP Education Ltd (ASX: IEL)

IDP Education provides placement services for international students into educational institutions in Australia, the UK, America, Canada, and New Zealand. Some of the other services that it provides include student counselling, application processing, and English language testing.

IDP Education has achieved a fantastic return on shareholders' equity of 48% in 2017, with similarly high returns forecast for the next few years. The company's market capitalisation has been rapidly growing, and currently sits at around $1.89 billion. However, the market cap will be much larger if it continues to compound at 45%, which it could well do on the back of the strong education sector in Australia.

Integrated Research Limited (ASX: IRI)

Integrated Research is a global provider of proactive experience management solutions for critical IT infrastructure, payments and communications ecosystems. Its unified communications segment provides solutions to maximise online user experience, for example by providing call quality troubleshooting and proactive alerting.

Its call centre segment provides solutions to optimise customer call centre experiences. Its payments segments keeps customers up-to-date with payment technologies and enables transition to the latest technologies. Lastly, its infrastructure segment provides infrastructure and IT service management.

The growth in online retailing has been fast, but online retailers will need to maintain a focus on delivering a high quality customer experience. This is where Integrated Research can really benefit on the back of a growing market. Its current market capitalisation is around $667 million, and it achieved a return on equity of 38% last financial year.

Codan Limited (ASX: CDA)

Codan is engaged in the development of electronic solutions for government, non-government, and consumer markets. Its businesses include radio communications, metal detection, mining automation, and defence electronics.

Codan has a market cap of around $438 million, placing it firmly in the small cap space. Its diverse businesses each target reasonably large markets, and these give Codan room to grow in multiple areas. In the 2017 financial year, the company achieved a return on equity of 27%. If it continues to compound shareholders' equity at 27% the company would be a great addition to any portfolio. However, analysts have forecast a small reduction in return on equity to around 20% for the next 3 years.

Foolish takeaway

Idp Education, Integrated Research and Codan are three small cap businesses with lots of room for growth that could compound returns at high rates. I'd buy these three businesses to hold them for many years, and let management do the work to compound my wealth.

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Warren Buffett is very clear that the heart of his investing philosophy is buying wonderful companies at fair prices.

While the rest of us may not possess the insight of Buffett when determining what constitutes a wonderful company at a fair price, Joel Greenblatt has simplified Buffett's approach into an easily understandable formula.

Greenblatt's 'Magic Formula' balances high returns on invested capital (a measure of business quality) with a measure of value (EBIT/enterprise value).

According to Greenblatt, and supported by evidence published more recently, the 'Magic Formula' beats the market.

Here are five companies that fit the profile of the type of companies that are sought by Greenblatt – companies with high returns on invested capital that represent fair value.

Macquarie Atlas Roads Limited (ASX: MQA)

Macquarie Atlas Roads own and operate toll roads, bridges and tunnels in France, the United States and Germany. The company invests in global infrastructure assets that generate stable cash flows and offer potentially resilient long-term performance through economic cycles. Based on last year's financial reports, Macquarie Atlas Roads has a return on invested capital of 24.9%, and it currently trades at an EBIT/enterprise value of 10%.

Fortescue Metals Group Limited (ASX: FMG)

Fortescue is an iron-ore miner that produces iron ore from mines in Western Australia. The share price has come under pressure due to declining prices for its lower grade iron ore. Based on 2017 financial reports, Fortescue has a return on invested capital of almost 20%, and an EBIT/enterprise value of 22%.

Qantas Airways Limited (ASX: QAN)

Qantas Airways provides air transportation within Australia and internationally. It also sells worldwide and domestic holiday tours. The share price has rallied recently on the back of tailwinds such as lower oil prices and changing investor sentiment around airlines. In 2017 Qantas reported a return on invested capital of 19%, and currently has an EBIT/enterprise value of 13.8%.

Codan Limited (ASX: CDA)

Codan is engaged in the development of electronic solutions for government, non-government, and consumer markets. Its businesses include radio communications, metal detection, mining automation, and defence electronics. In 2017 Codan reported a return on invested capital of 93, and it currently trades at an EBIT/enterprise value of 15.8%.

Adairs (ASX: ADH)

Adairs is a retailer of manchester and homewares. The company has over 160 stores across Australia in five physical store formats, comprising Adairs, Adairs Homemaker, Adairs Kids, UHR and Adairs Outlets. Adairs last reported a return on invested capital of almost 40%, and trades at an EBIT/enterprise value of 8.7%.

Foolish takeaway

These five companies offer a reasonable balance between business quality and value, typical of that sought by Warren Buffett and Joel Greenblatt. I'd be happy to buy them today with the view of capital growth throughout 2018.

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For many reasons, it is easy to think that we've 'missed the boat' when the share price of strong growth companies has skyrocketed. We tend to anchor to the price at which we first looked at (and decided not to buy) a company's shares.

While it is true that strong growth often attracts competitors, which can reduce margins or market share, there are some businesses with moats that are sufficiently strong to maintain high levels of growth over a long period of time.

Here are 3 companies that have reported high rates of growth over the last few years, and that I believe may still have a lot of growth left.

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.

Fisher & Paykel has multiplied net profits by more than 5 times since 2008 when it reported a net profit of 30.5 million, or 5.8 cents per share. It last reported earnings per share of 30.2 cents in 2017. Analysts have forecast 20% growth in earnings per share for 2018 and 2019. With increasing awareness and diagnosis of issues such as sleep apnoea, the company potentially has a long runway for growth. However, anticipated growth may already be priced in as shares currently trade at 40 times earnings.

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.

The company started reporting consistent positive earnings per share in 2012 when it reported earnings of 7 cents per share. Last year, Altium reported earnings of 30.8 cents per share – an increase of over 4 times 2012 earnings. Analysts have forecast earnings of 39 cents per share in 2018, 48 cents per share in 2019, and 58 cents per share in 2020. However, shares currently trade at 66 times last year's earnings, and 35 times forecast 2020 earnings.

Corporate Travel Management Ltd (ASX: CTD)

Corporate Travel Management provides travel management solutions to the corporate market. Apart from corporate travel, the company offers travel management for sport, event, resource, and leisure travel.

Since 2010, Corporate Travel Management have increased earnings per share over 11 times, from 4.7 cents in 2010 to 54 cents in 2017. Analysts have forecast earnings per share of 81 cents in 2018, 95 cents in 2019, and 108 cents in 2020. As with Fisher & Paykel and Altium, growth has been factored into the share price already. Shares currently trade on a price to earnings of almost 37.

Foolish Takeaway

Fisher & Paykel Healthcare, Altium and Corporate Travel Management have a strong history of growth as well as strong forecasted growth. However, there is a price at which it is no longer sensible to buy into a business, despite its growth. It seems to me that the growth has been factored into the current price. If you think that the companies can beat forecasts, than I'd buy today. Otherwise, it may pay to sit on the sideline for just a little longer.

Alternatively, these shares may be even better investments in 2018.

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Worldwide interest rates are at historically low levels. They have been this way for some years now. The Reserve Bank of Australia has left the cash rate at 1.50% since August 2016. The last time it lifted the cash rate was way back in November 2010 when it set the cash rate at 4.75%. Since then, it has made 12 separate rate cuts over 7 years.

However, rates can't and won't stay so low forever. The United States Federal Reserve has reacted to a strengthening economy by lifting rates and has signalled its intention to continue to lift rates throughout 2018.

Low rates have strengthened share prices as companies have been able to borrow money at very low rates and use it for business growth. In some cases, this can cover over the cracks of a poor business model. As interest rates begin to rise, those companies with large debts and poor cash flow will begin to suffer.

Here are a few companies who are well placed to withstand rising interest due to relatively low levels of debt and good cash flow.

Cochlear Limited (ASX: COH)

Cochlear is a manufacturer and distributor of cochlear implantable devices for people who are hearing impaired. The company has operations in more than 20 countries across the Americas, Asia, the Middle East, Europe and Asia Pacific regions.

To June 2017 Cochlear reported earnings before interest and tax (EBIT) of $315.6 million. With interest expenses of $6.8 million, Cochlear can cover its interest expenses with EBIT 46.4 times.

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.

To March 2017, Fisher & Paykel reported EBIT of $238.2 million and interest expenses of $1.5 million. Fisher & Paykel can cover its interest payments with EBIT a total of 158.8 times.

Reece Ltd (ASX: REH)

Reece is an importer, wholesaler, distributer, marketer and retailer of bathroom and plumbing products and services. The company also provides irrigation products, civil products, onsite services, and spare parts for heating, air conditioning, and refrigeration products.

To June 2017 Reece reported an EBIT of $307.9 million. With interest expenses of $4.8 million, Reece can cover its interest expenses with its EBIT 64 times.

Bellamy's Australia Ltd (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.

Last financial year Bellamy's reported EBIT of $36.3 million, and interest expenses of $1.3 million. That means that Bellamy's can cover its interest payments a total of 27.9 times based on its 2017 financial reports.

Foolish takeaway

Maintaining low levels of debt and generating high levels of cash mean that companies are well placed to ride a rise in interest rates through 2018. The four companies mentioned above are good quality businesses and rising interest rates won't hamper their efforts for growth.

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