For investors looking to assemble a portfolio of lasting, high-standard businesses, the quality investing method provides a structured system. This system centers on finding companies with durable competitive strengths, high profitability, reliable growth, and sound financial condition, with the goal of owning them for many years. One useful instrument for this hunt is the "Caviar Cruise" stock screen, which uses measurable filters to find firms displaying these key characteristics. The screen looks for steady revenue and profit increase, high returns on invested capital, good free cash flow production, and a reasonable amount of debt.
A recent use of this screen has identified NetEase Inc-ADR (NASDAQ:NTES) as a candidate for more detailed review. The Chinese technology and entertainment company seems to match a number of central ideas of quality investing.
Reviewing the Main Quality Measures
The Caviar Cruise method uses defined financial limits to judge a company's operational strength and financial durability. NetEase's recent financial reports show a good match with these standards:
- Profitable Growth: The method requires companies to have a record of increasing both revenue and earnings. NetEase's 5-year revenue CAGR of 9.6% and EBIT CAGR of 16.5% are above the screen's 5% minimums. Importantly, EBIT increase being higher than revenue increase, as shown here, points to better operational efficiency and possible pricing strength, important signs of a quality business.
- Outstanding Capital Efficiency: A central part of quality investing is judging how effectively a company produces profits from its capital. The screen asks for a Return on Invested Capital (leaving out cash, goodwill, and intangibles) over 15%. NetEase's number of about 133% is very high, indicating the company uses its capital with notable success to build value for shareholders.
- Financial Strength and Cash Flow Soundness: Quality investors look for financial soundness. Two filters deal with this directly:
- Debt Management: The Debt-to-Free Cash Flow ratio shows how many years of present cash flow would be required to repay all debt. A ratio under 5 is viewed as sound. NetEase's ratio of about 0.16 is very good, showing a very small debt load and great financial room to maneuver.
- Cash Conversion: The "Profit Quality" measure calculates the percentage of net income turned into free cash flow over five years. A result over 75% is sought, showing earnings are supported by actual cash. NetEase's average of about 133% is well above this, indicating not only sound earnings but also that the business produces extra cash beyond its stated profits.
A Look at the Fundamental Analysis
A wider examination of NetEase's fundamental condition, as covered in its detailed analysis report, supports the view given by the screen. The company receives a sound total score of 7 out of 10, with very high marks in Profitability (9/10) and Financial Health (8/10).
Main points from the report are:
- High Profitability: NetEase has top-tier margins and returns, with a Profit Margin of 32.45% and an ROIC of 17.58%, each better than over 90% of its entertainment industry competitors.
- Strong Balance Sheet: The analysis agrees with the screen's results, noting a "very positive" debt-to-FCF ratio and sound liquidity measures like a Current Ratio of 3.42.
- Fair Valuation: Even with its quality features, NetEase seems fairly valued. Its P/E ratio of 15.8 is lower than 83% of its industry competitors and is under the present S&P 500 average, hinting the market may not completely account for its lasting competitive strengths.
Points for the Quality Investor
While the number-based filters give a positive view, the quality investing idea also needs qualitative assessment. NetEase's leading place in the Chinese online gaming market, its growing projects in music, education, and cloud services, and its experienced management team point to the less measurable parts of a quality company: competitive defenses, able leadership, and connection to long-term digital consumption shifts. Still, investors must also think about geopolitical and regulatory elements linked to its main area of operation.
Locating Other Quality Candidates
NetEase acts as a clear example of the sort of company the Caviar Cruise screen is made to find. For investors wanting to examine other companies that meet these strict tests for profitable growth, capital efficiency, and financial soundness, you can see the present screen results here.
Disclaimer: This article is for information only and is not financial advice, a suggestion, or an offer to buy or sell any security. Investing has risks, including the possible loss of the amount invested. You should do your own research and talk to a qualified financial advisor before making any investment choices.
