If someone held a gun to my head and said I had to sell all of...

If someone held a gun to my head and said I had to sell all of my investments and put the proceeds into just one stock, either ARP or Reece (REH) would be that stock.

Both are commercially scalable, conservatively managed business with strong financial pedigree, high-quality brands and significant pricing power. Their balance sheets are in pristine condition (both companies have net cash equal to around 5% of their respective market caps), their financial accounts are presented with plenty of prudential conservativeness, and their respective management teams have significant alignment with shareholders.

For two companies that operate in distinctly different business sectors (4WD spares and accessories versus plumbing supplies), the financial performance of the two businesses are remarkably similar.

GROWTH TRACK RECORD
Since listing, compound average annual growth rates are as follows:
* REVENUE
ARP = 16.4%
REH = 13.1%
* EBIT
ARP = 20.7%
REH = 15.0%
* EPS
ARP = 19.8%
REH = 15.1%

MARGINS
* Gross Profit Margin
ARP = 52%
REH = 31%
* EBIT
ARP = 19.6%
REH = 10.9%
* Free Cash Flow Margin
ARP = 14.5%
REH = 10.6%

CAPITAL INTENSITY
* Working Capital-to-Sales
ARP = 19.8%
REH = 14.8%
* Capex-to-Sales
ARP = 2.6%
REH = 2.0%
* Operating Cash Flow-to-Capex
ARP = 6.9x
REH = 6.3x
* Asset Turn
ARP = 5.4x
REH = 4.9x

RETURNS
* RETURN ON TOTAL CAPITAL
ARP = 27%
REH = 17%
* RETURN ON EQUITY
ARP = 31%
REH = 20%

ACCOUNTING QUALITY
* CASH FLOW CONVERSION (EBITDA-TO-NET RECEIPTS)
ARP = 98%
REH = 100%
* PP&E-TO-DEPRECIATION (ASSET WRITE-DOWN PERIOD)
ARP = 7.5 years
REH = 10.9 years
* CAPEX-TO-DEPRECIATION
ARP = 1.0x
REH = 1.1x

In summary, while I am inclined to believe ARP is the better business by only a modest degree, these are both exceptional companies that have created significant shareholder value over the years, and that I believe will continue to do so in the years to come.

Provided, as always, they are acquired at the right price.
So, let's look at valuations:

On my favourite measure, namely Free Cash Flow-to-Enterprise Value, neither stock is undervalued:
* FCF/EV
ARP = 6.8%
REH = 5.9%

On EV/EBITDA multiples, my next favoured valuation metric, ARP is the slightly cheaper stock, but again is not a glaring sell:
* EV/EBITDA
ARP = 8.9x
REH = 9.3x

Moving down the valuation chain:
* P/E
ARP = 15.1x
REH = 16.9x
* Dividend Yields
ARP = 3.1%
REH = 3.2%

Given the growth track record, as well as the future growth prospects of these two businesses (I think they are both capable of compounding EPS and DPS growth by 105 to 15% pa for the next decade, on a medium-to long-term views they present compelling valuation, in my view.

However, on a short-term basis (which I suspect is where 95% of HC subscribers pitch their investment time horizon). So if readers of this post are shareholders in ARP or REH, and are looking for short-term gains, I don't think you will get them.

So feel free to offload your shares in favour chasing the latest hot commodity, whatever that is this week (rare earths? or was that last week? or tin, maybe? or polystyrene? or DRam?).

I am unashamed to disclose that, as a long-term owner of these businesses, I will be standing by to mop up any selling pressure that might arise.

So, in conclusion, short-term investors, these stocks are overvalued. Please feel free to sell them.

Cameron