For investors looking to assemble a group of lasting, successful businesses, the quality investing method provides a useful structure. This method centers on finding companies with durable competitive strengths, reliable earnings, sound finances, and the capacity to produce high returns on capital over many years. The "Caviar Cruise" stock screen puts this method into practice by selecting for firms with a record of sales and earnings increase, high returns on invested capital, good cash flow, and low debt. The aim is not to locate temporary discounts, but to identify businesses suitable for lasting ownership.
A recent run of this screen highlighted Federal Signal Corp (NYSE:FSS), a maker of environmental and safety products. A look at its financial details shows a number of traits that match the principles of quality investing.
A History of Earnings Increase
Central to quality investing is the need for reliable, profitable growth. The Caviar Cruise screen asks for at least a 5% compound annual growth rate (CAGR) for both sales and EBIT (earnings before interest and taxes) over five years, with EBIT increase preferably higher than sales growth, a marker of better operational effectiveness and pricing strength.
Federal Signal easily meets these minimum standards:
- Sales Increase (5Y CAGR): 7.4% – Shows a steady capacity to grow its sales.
- EBIT Increase (5Y CAGR): 13.7% – Considerably higher than sales growth, showing that earnings are rising quicker than sales. This suggests successful cost control, economies of scale, or a positive change in its business composition.
This past performance is supported by optimistic forecasts; analysts estimate future sales growth will proceed at a good rate, backing the view that the company's growth path is durable.
Outstanding Returns on Capital and Sound Finances
Maybe the most important measure for a quality investor is Return on Invested Capital (ROIC), which calculates how well a company produces earnings from its capital. A high and steady ROIC is a sign of a business with a lasting competitive advantage. The screen establishes a high standard with an ROIC (leaving out cash, goodwill, and intangibles) over 15%.
Federal Signal is notable here, with a present ROIC of 30.2%. This remarkable number shows that for each dollar put into the core business, the company creates over thirty cents in profit. It puts FSS in the leading group of its industry and is a clear sign of very good capital use and operational performance.
Financial strength is also key. The screen uses the Debt-to-Free Cash Flow (FCF) ratio to confirm a company can easily handle its debts. A ratio under 5 is seen as sound, indicating it would need less than five years of current FCF to pay off all debt. Federal Signal performs very well with a Debt/FCF ratio of 0.97, meaning its yearly free cash flow almost matches its total debt. This very strong balance sheet gives important flexibility to handle economic changes, fund growth, or give capital to shareholders.
Reliable Earnings
Quality investing stresses the value of cash flow. A company can state accounting profits without creating actual cash. The Profit Quality measure—the ratio of Free Cash Flow to Net Income—checks this. The screen searches for a five-year average over 75%, making sure stated earnings are supported by real cash.
Federal Signal’s 5-year average Profit Quality is 76.6%, satisfying this condition. This implies the company’s net income is consistently turned into cash, adding trust to its earnings statements and supplying the means for dividends, share repurchases, or new investment.
Fundamental Rating Summary
An inspection of Federal Signal’s detailed fundamental analysis report supports this quality picture. The report gives FSS a good total score of 7 out of 10, with specific high scores in Profitability (8/10) and Financial Health (7/10). Important points include:
- Profitability: The company scores well on return measures (ROA, ROE, ROIC) and shows widening operating and profit margins.
- Health: It has a very good Altman-Z score (showing low bankruptcy risk), very strong liquidity ratios, and the previously mentioned excellent debt situation.
- Growth: The company shows good past growth in both sales and EPS, with steady growth estimated to persist.
- Valuation: The stock is not inexpensive on a normal P/E basis, which is common for high-quality companies. Still, its price seems more fair when accounting for its growth outlook and outstanding profitability.
Is FSS a Quality Investment Prospect?
Judging by the numerical filters of the Caviar Cruise screen, Federal Signal Corp makes a strong argument. It displays the signs of a quality business: a past of profitable growth, outstanding returns on capital, very sound financial health, and reliable earnings. These characteristics suggest a business with competitive strengths in its specific markets for environmental and safety gear.
For investors using a quality-focused, long-term strategy, FSS deserves more study. Its financial numbers indicate a company that is not only doing well but is structured to endure difficulties and grow capital over the long term.
Interested in reviewing other companies that meet the Caviar Cruise screen? You can execute the screen yourself and view the complete list of findings here.
Disclaimer: This article is for information only and does not form financial guidance, a suggestion, or an offer to buy or sell any security. The data shown is from sources thought to be dependable, but its correctness cannot be assured. Investors should perform their own research and talk with a qualified financial advisor before making any investment choices.
