Charlie Munger is one of the most prominent investors in the world. Charlie runs Berkshire Hathaway, along with Warren Buffett. So, when Munger speaks, it pays to listen.
Charlie is famous for his slow-and-steady, buy-and-hold style of investing. He likes to buy great companies and sit on them for decades. Great companies just like Reckitt Benckiser (LSE: RB) and Unilever (LSE: ULVR).
A great result
Charlie Munger’s logic is simple. If you buy a good business with a great set of products, over time the returns generated from the business will stack up. As a result, even if you pay a high price for the business, you’ll end up with fine results.
Key to this concept is a company’s return on capital employed. Simply put, ROCE is a telling and straightforward gauge for comparing the relative profitability levels of companies. The ratio measures how much money is coming out of a business, relative to how much is going in and is a great way to measure business success.
Company ROCE figures can vary dramatically from year to year but if you can find a company with stable ROCE that’s higher than the market average, you’re onto a winner.
According to my figures, only one third of the world’s 8,000 largest companies managed to achieve an ROCE of greater than 10% last year. However, over the past 10 years Unilever’s average annual ROCE has been in the region of 22%. Reckitt’s has come closer to 30% per annum.
These figures show that Unilever and Reckitt are both quality business, which are able to achieve some of the highest levels of profitability around.
Paying a premium
With this in mind, it makes sense to pay a premium to get your hands on Unilever and Reckitt’s shares. At present levels, Reckitt trades at a forward P/E of 25.4 and offers a dividend yield of 2.1%. Unilever currently trades at a forward P/E of 22.2 and is set to yield 3.1% this year.
Usually, I would be wary of such lofty valuations. P/E ratios in the mid-20s usually indicate that the market has high hopes for the company in question. Unfortunately, more often than not the company fails to live up to expectations. But the same logic doesn’t apply to Unilever and Reckitt.
Indeed, the two companies produce a selection of essential everyday household items, the sales of which are easy to predict. Therefore the businesses are defensive by nature and the high returns on capital should be sustainable.
