For investors aiming to assemble a portfolio of lasting, high-achieving businesses, the quality investing philosophy offers a strong framework. This method centers on finding companies with durable competitive strengths, sound financial condition, and the capacity to produce steady, high returns on capital over many years. Instead of searching for large discounts, quality investors frequently accept a reasonable price for outstanding businesses they can keep for a long time. A structured method to find these candidates is through a specific stock screener, such as the "Caviar Cruise" approach, which selects for firms with high profitability, solid growth, and financial durability.
One company that appears from this strict screening process is ResMed Inc. (NYSE:RMD), a worldwide leader in digital health and cloud-connected medical devices for treating sleep apnea, chronic obstructive pulmonary disease (COPD), and other respiratory conditions. A detailed review shows how ResMed's financial characteristics match the central principles of quality investing.
Financial Strength and Profitability
The Caviar Cruise screen puts great importance on a company's capacity to produce high returns on the capital put into its main operations. This is measured by the Return on Invested Capital (ROIC), with a minimum requirement of 15%. A high ROIC points to a lasting competitive advantage, often called an economic moat, where a company can effectively turn investment into profit. ResMed performs well here, with an ROIC (excluding cash, goodwill, and intangibles) of about 64%. This high number is not unusual; the company's three-year average ROIC is a solid 18.06%, and it has increased lately. This result indicates ResMed's business model is very effective and efficient with capital.
Additionally, the screen demands strong and rising profitability margins, which show pricing ability and operational effectiveness. ResMed's numbers are impressive:
- Operating Margin: 34.11%, higher than over 99% of its healthcare equipment industry peers.
- Profit Margin: 27.53%, better than 97% of the industry.
- Both margins have increased over the last five years, confirming a pattern of rising profitability along with revenue growth.
Growth and Quality of Earnings
A quality company should show steady growth, not only in total revenue but, more critically, in its core operating profit (EBIT). The screen requires a 5-year compound annual growth rate (CAGR) above 5% for both revenue and EBIT, with EBIT growth preferably higher than revenue growth. This shows the company is becoming more profitable as it gets larger.
ResMed satisfies and surpasses these requirements:
- 5-Year Revenue CAGR: 8.4%
- 5-Year EBIT CAGR: 15.8%
The reality that EBIT growth is almost twice the revenue growth is a clear sign of a quality business gaining from economies of scale and strong operational effects. It shows that more of each extra dollar of sales becomes operating profit.
The screen also assesses the "quality" of reported profits by looking at how much net income becomes actual free cash flow, the real cash available for dividends, share repurchases, or debt payment. ResMed's 5-year average Profit Quality score is 92.4%, far above the 75% minimum. This high conversion rate shows that the company's earnings are supported by genuine cash generation and are not just accounting results.
Prudent Financial Management
Long-term durability is essential for a buy-and-hold investor. The Caviar Cruise method assesses financial condition by examining the Debt-to-Free Cash Flow ratio, which indicates how many years it would take to pay off all debt using current cash flow. A ratio under 5 is seen as strong. ResMed's ratio is excellent at about 0.37, meaning it could in theory pay its complete debt in less than five months with its current free cash flow. This points to a very strong balance sheet with little financial risk, letting the company manage economic changes and fund future growth from a secure position.
High-Level Fundamental Summary
A look at ResMed's detailed fundamental analysis report supports the findings from the quality screen. The report gives RMD a good overall fundamental rating of 7 out of 10. Important points include:
- Profitability Rating: 9/10 – Recognized for high returns on assets, equity, and invested capital.
- Financial Health Rating: 8/10 – Pointing out a very strong Altman-Z score, very little debt, and high liquidity.
- Dividend Rating: 7/10 – Noted for a steady, increasing dividend with a maintainable payout ratio.
- Growth Rating: 6/10 – Recognizing strong historical growth in revenue and EPS, with good, though slightly slowing, growth expected in the future.
- Valuation Rating: 5/10 – While not inexpensive on an absolute P/E basis, the valuation is viewed as fair compared to the industry and the S&P 500, particularly given the company's high profitability.
A Candidate for the Quality Portfolio
ResMed makes a strong argument for quality investors. It works in an increasing market fueled by long-term demographic and healthcare patterns, has clear competitive strengths in its connected device and software system, and displays the financial signs of a superior business: high and rising returns on capital, strong cash-based profitability, and a clean balance sheet. While valuation always needs thoughtful study, the company's financial profile indicates it has the traits quality investors look for in a long-term holding.
For investors wanting to find other companies that meet similar strict quality filters, you can view the current Caviar Cruise screen results here.
Disclaimer: This article is for informational purposes only and does not constitute financial advice, a recommendation, or an offer to buy or sell any security. Investing involves risk, including the potential loss of principal. Readers should conduct their own research and consult with a qualified financial advisor before making any investment decisions.
