Sunday, December 9, 2012

Roper Industries Remains Attractive

Previously I wrote that Roper Industries (NYSE: ROP) was the best run company in America. That article will serve as a good primer for the company. In this article I want to do two things: first, flesh out what you can learn from Roper’s management in your own investing; second, discuss how it’s applying these principles in running its own business.

What Makes Good Management?

Frankly I can’t contribute anything new to the tomes of verbiage on management technique, but I can describe some attributes that good management might have in common with investors. Of course the big advantage that private investors have over management is that they can change their interest or investment with a short call to their order taker or a few clicks of a mouse. On the other hand, managers are tied to their businesses and more often than not their industry sector.

In this regard you have to judge a manager in line with how he is performing within his industry. This applies in the good times as well as the bad. The same applies to investors or anyone who claims to be an investor. There is no point listening to loud mouthed television presenters whose only demonstrable track record is a bit of outperformance in a raging bull market. There is nothing clever about taking on excess risk and getting lucky for a few years in an up market. Neither is there any point in getting excited about certain hedge fund managers who made huge sums in 2008 only to lose huge amounts in their flagship funds in the years afterwards.

Bearing this in mind, what you are looking for with company management is a good track record of performance across all market conditions. While they can’t do much about the industries they are in, they can concentrate on generating cash and reinvesting it with the aim of diversifying and chasing growth markets.

In a sense, this is what stock investors should also be doing. However, for some reason, the media and investment communities are fixated on ‘one-hit wonders’ who just happen to outperform because their strategy happens to fit market conditions for a short while.

Why Roper Industries Fits the Bill

I think Roper is a good example because even through the last recession it carried improving operational performance within its key metrics. For example, let’s look at its cash flow conversion updated in line with the latest numbers.

Sure there is the inevitable dip in business during the recession, but let’s consider how Roper was positioned going into the recession in relation to an industry bellwether like General Electric (NYSE: GE). The latter’s management had continually chased the idea of driving internal demand by increasing its GE Finance operations. The end result is known to all, and GE shareholders are still suffering the consequences of this as GE continues to take losses on the reduction of non-core finance operations.

ROP data by YCharts

Roper’s guiding principle seems to be to excel within its chosen niche markets, and it has made a series of earnings enhancing acquisitions over the years. While these principles are easily understood, they are much harder to apply. Consider the case of Cisco Systems (NASDAQ: CSCO), which seems to have lost its way in recent years. It tries to compete in a host of different IT markets but often finds itself second best. Meanwhile, some of its acquisitions seem to have been poorly judged (ex. Tandberg Television) and it is even finding itself challenged in its core switching and routers products.

Roper is also distinguished by diversification in its end markets, so while its medical & scientific segment is facing slowing growth from academic demand within imaging, Roper’s acquisition of medical software company Sunquest has immediately been earnings accretive and puts the division back on a growth path. Contrast this situation with that faced by Hewlett-Packard (NYSE: HPQ), which is trying to restructure but is so debt laden and over exposed to structurally declining industries (printers/PCs etc) that it is in a very difficult position. Hewlett-Packard did not have enough diversification, and the Autonomy acquisition could be seen more as an expensive gamble then being part of a solid business plan.

The Bottom Line

Roper’s management is exhibiting all the hallmarks of what you should look for in a management. They are focused on generating cash in their shareholders' interests, which is then reinvested in earnings enhancing acquisitions. They don’t chase unsustainable growth by over-investing in hot sectors, and they focus on winning within a collection of niche and diversified end markets. In addition, they haven’t been ‘lucky’ by hitting the right industry at the right time and then fading as market conditions change; it isn't a one trick pony.

On the contrary, it has been a story of sustained performance across a range of market conditions.  Margins are expanding, the Sunquest acquisition appears to be a success and the midpoint of full year guidance was raised at the last results.

I think the analogy between what you look for in an investor and in a management is a strong one, and the mix of diversified high margin growth industries at Roper should stand investors in good stead throughout most economic cycles. I would trust someone investing in the principles that Roper has demonstrated over the years, and I think the company itself deserves a premium in its sector.

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