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No. of Recommendations: 10
(From the Liquid Lounge board...)

These "what works on Wall Street" posts are always instructive.

I just finished studying Hansen Natural (HANS), the best performing stock for the 10 years ending 2006, according to an excellent column that was published in the free site several months ago by Tim Hanson.

(How good was the stock? Try turning a $10,000 investment into $2.6 million good.)

Hansen's growth during 1997-2002 was unremarkable. But then the beverage maker's profits -- and profitability -- rocketed. Some interesting data points for 2002-2006:

1. "Museum quality" Earnings Power Staircase. (What's this? See my site here http://www.earningspower.com/staircase.html)

2. Sales growth (5-year CAGR): 44%

3. Gross profit margin (5-year average): 45%

4. Return on capital (5-year average): 34%

5. Return on incremental capital (5-year average): 117%. (In 2006, HANS's ROIC was "just" 35%.)

6. Profits growth (5-year CAGR): defensive (free cash flow): 57%; enterprising (Economic Value Added): 126%

7. Sustainable growth rate (5-year average): 31%

If you seek "the next Hansen" like I do, then benchmark the growth-type companies you own against this star performer. Sell the slackers to free up time and money for more promising opportunities.

All of the numbers above are fantastic. But Hansen's return on incremental capital is especially impressive. For every dollar of profit that management reinvested, the Corona, CA-based business generated $1.17 of pre-interest, after-tax profit. Most companies are lucky to produce $0.15-$0.25 of incremental profit.

Because return on incremental profit is tough for management to fake (overpay for an acquisition to buy growth and, zap!, the cost is recorded in the denominator), it is one of the 2-3 most important ratios you can have in your spreadsheet. Here's the simplified formula: incremental profit (after-tax but before interest expense) divided by incremental capital.

I have not valued Hansen yet so I do not know if it sells at a discount to intrinsic value.



Hewitt Heiserman
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