Greggs (LSE: GRG) shares have soared in recent years. Over the last two years, the food-on-the-go retailer’s share price has climbed nearly 50%.
Looking ahead, I reckon the shares have the potential to keep rising. Given the attributes of this business, I wouldn’t be surprised to see the share price rise significantly over the next decade.
A high-quality business
Greggs isn’t a cheap stock. Currently, it sports a price-to-earnings (P/E) ratio of about 21 (using next year’s earnings forecast). That’s well above the UK market average.
But that doesn’t mean the stock can’t rise from here. You see, Greggs is a high-quality company with a strong brand and a high return on capital employed or ‘ROCE’ (a key measure of profitability). Last year, its ROCE was 22% – well ahead of the UK market average.
Now, companies that have strong brands and a high ROCE often get much bigger over time. That’s because they’re able to reinvest and ‘compound’ their profits at a high rate.
This can lead to exponential business growth. In the same way that compound interest can make savers very wealthy over time, compounded profits can lead to huge growth for a company.
Investing in businesses with these attributes has been one of the keys to Warren Buffett’s success over the years. When looking for stocks for Berkshire Hathaway, Buffett and his late business partner Charlie Munger would typically seek out high-quality companies with high returns on capital.
Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.
Charlie Munger
Ultimately, a high ROCE can be very powerful. When I’m searching for stocks to buy, it’s one of the first things I look for.
The growth story
Of course, Greggs’ success over the next decade will depend largely on its ability to roll out new shops across the UK. It has big plans here. For example, this year, it wants to roll out a total of 140-160 new outlets.
However, the risk is that it saturates the market at some stage and can’t expand at the rate it’s been used to. This could lead to a slowdown in growth and lower returns for investors.
It seems the company believes it has plenty of potential in the long run however. “The Board remains confident in the long-term growth strategy, and we are investing to support that growth,” said CEO Roisin Currie in the company’s recent H1 results.
So taking a long-term view, I’m optimistic about this stock’s prospects and see it as one to consider. It’s worth noting that analysts at Berenberg just raised their 12-month target price to 3,600p. That’s about 16% above the current share price.
This post was originally published on Motley Fool
