Not all growing retail chains are healthy. To see what I mean, head to the nearest Circuit City, Linens n' Things or Chi-Chi's. If you have trouble finding them, it's because all three have closed most or all of their stores. They grew to the point where their names are still familiar, but in doing so, they committed so much capital that they were unable to survive setbacks, including increased competition, a spending downturn and, in the case of the Mexican eatery, a Hepatitis A outbreak linked to green onions.
The companies listed below are expanding their sales and profits, but more important, they're doing so while producing generous returns on capital. Return on capital is a company's profit divided by the amount of money, whether borrowed or owned, that it has put to work to create that profit. Companies with high returns on capital tend to reward investors with market-beating stock returns--especially when such companies are modestly priced to begin with. The ones below have reasonable share prices relative to the free cash they've cleared over the past year.
Bed Bath & Beyond
Return on long-term capital: 20%
Bed Bath & Beyond (BBBY) has benefitted from the aforementioned demise of Linens n' Things and from a rebound in consumer spending. Last quarter, its sales at longstanding stores jumped 7%. The company operates nearly 1,000 of its namesake home furnishing stores but has fewer than 50 Buy Buy Baby stores, which gives it a combination of strong cash flow and ample potential for expansion. Over the past year the company generated $896 million of free cash, equal to 6% of its stock market value. Management seems keen to put most of the cash toward share repurchases. Last quarter alone it spent $245 million to retire stock. Wall Street expects the company's sales to increase by 8% this year and its profits by twice as much.
Return on long-term capital: 34%
Apple (Aapl) is a device and software company, but it's also a retailer, with 323 stores, including 16 high-profile ones in pricey locations designed to generate buzz and handle corporate accounts as well as sell to walk-in customers. With a stock market value of more than $300 billion, Apple is America's second-costliest company behind Exxon Mobil (MOB), worth $380 billion. Relative to the company's prosperity, however, its shares aren't as pricey as they might seem. They sell for 13 times forecast earnings for the fiscal year ending September. Apple sits on close to $66 billion in cash and securities, so the company minus its idle funds sells for only 10 times earnings, making it nearly one-third cheaper than the broad U.S. stock market.
Return on long-term capital: 20%
Big Lots (BIG) has closed 145 under-performing stores in recent years. It now turns more than seven cents of each sales dollar into operating profit, a penny better than Wal-Mart (WMT) . There's more work to be done; management says it expects sales at longstanding stores to be flat or decline as much as 2% this year. But there's much to like about the stock. The company recently decided not to sell itself, and its shares, which had jumped by one-third this year in anticipation of a deal, gave it all back. They now trade at just 11 times earnings. The company has no debt and holds about 10% of its stock market value in cash. And as a closeout retailer, Big Lots is arguably positioned to prosper in the event the economy worsens--something that can't be said of most stores.