Australia's 10 best businesses

Greg Hoffman

October 5, 2010 - 2:59PM

Computershare is one of the five businesses to make it onto The Intelligent Investor's 10 Best Businesses list two years running. It's produced impressive figures; 40 per cent annual dividend growth over the past decade, a return on capital in the mid-teens and a return on incremental capital (the additional capital that's been put in over the past decade) of more than 20 per cent.

So why has the company's share price lagged the All Ordinaries index over the past 10 years?
In a word, ``expectations''. A decade ago, after a staggering 36-fold increase over the prior five years, investors were paying a price-to-earnings ratio (PER) of more than 100 for Computershare.

A PER much above 20 requires decent profit growth in order to justify it; at over 100 it had become extremely stretched. That fact that investors who paid those tech boom prices have been able to achieve positive returns at all is remarkable enough.

Finest businesses

In what's now an annual, post-reporting season ritual, our team has recently crunched the numbers and arrived at a list of the finest businesses listed on the Australian sharemarket.

It's a subjective exercise, of course, but the process we think is quite robust. Starting with all of the stocks in the ASX 200 index, we passed them through analytical filters such as

• 5- and 10-year dividend growth, 
• 10-year average return on capital employed and 
• return on incremental capital employed.

Share price performance is not one of the measures: if a business performs well on the measures we've selected, its share price is bound to take care of itself.

Computershare is perhaps the exception that proves this rule. It's the only one of the 10 businesses to make our final list whose total shareholder returns have failed to beat the market over the past decade. As renowned investor Ben Graham put it, in the short run the market is a voting machine, in the long run it's a weighing machine.

Competitive advantage

In analysing the final list of Australia's 10 Best Businesses, a number of themes emerged. The most important is that the key to great long-term investment returns is some form of sustainable competitive advantage.

This might be in the form of a strong brand like David Jones, a powerful distribution network of the likes of Woolworths and Metcash, or patented technology from a company like Cochlear. Yes, all these stocks made it onto the list of Australia's 10 best businesses.

Sometimes a competitive advantage can be built by reliably delivering results to clients over a long period, as is the case with Leighton and Monadelphous. But this is potentially a weaker type of advantage and one that could be lost more readily than other kinds.

Also, over a short period (say one to three years), it's difficult to distinguish between profits that are the result of a strong competitive advantage and profits that are the result of a powerful industry upswing.
Another point to consider is that a strong competitive advantage often doesn't last. Recently, shareholders of Tattersalls and Tabcorp have learned this the hard way. Exclusive government licences provide a strong advantage but they have a finite life and most of the `excess value' they generate will probably be competed away in the new licence bidding process.

Each year we find it useful to survey the investing landscape from this long-term, numbers-driven perspective. And, if you're keen to work through such calculations yourself, I'm currently recording a `how to' online video series, using Telstra as a case study. The first two videos are available now, and I'll be posting the others later in the week.

This article contains general investment advice only (under AFSL 282288).

Greg Hoffman is research director of The Intelligent Investor. BusinessDay

 http://www.brisbanetimes.com.au/business/australias-10-best-businesses-20101005-165i0.html