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danger sign emanating from Enron before its collapse was that its
top executives couldn't shut up. Specifically, they couldn't stop
talking about how wonderful their firm was — the "World's Greatest
Company," as a sign in the lobby of corporate headquarters in Houston
put it.
By contrast,
I like companies that keep their virtues hidden. The Great Unknown
is the best place to search for good stocks at good prices. Typically,
these obscure companies are in breathtakingly dull businesses, but
many of them are exceptionally well run, with solid balance sheets
and long histories of rising earnings.
You want dull?
Consider the lowly ball bearing — the little sphere, kept in
place by something called a "race," that's at the writing end of
ballpoint pens. Ball bearings make the world go around, yet few
investors know who makes them. One of the best companies is Kaydon
Corp. (KDN), which makes tiny bearings for valves and measuring
devices and big ones for giant hydraulic excavators.
No, recessions
aren't kind to ball-bearing manufacturers, but that's good for investors,
who can pick up their shares at bargain prices. Sales were flat
in 2001 at Kaydon, and earnings dropped, knocking the stock price
down to less than half its level of mid-1998 and making it an attractive
buy. The company has more cash than debt, and when the economy recovers
it should experience what analyst Elliott Schlang calls "a dramatic
rebound in earnings." Already, the stock has risen by more than
25% from its November low.
In a normal
year, Kaydon, which also makes such exciting products as rings and
seals for pumps and compressors, and filters that remove bad stuff
from fuel and lubricants, earns about $1.80 a share. It was recently
trading at $24, or about 13 times those typical earnings, and it
has a dividend yield of 2% — about half again as high as that
of the average stock.
Because most
investors don't pay much attention to them, stocks like Kaydon tend
to fall into the "value" category — that is, cheap and unloved.
The opposite of value is "growth" — that is, stocks whose prices
have risen quickly, along with their profits. Schlang is the master
of the boring value stock. Based in good, gray Cleveland, he runs
a research outfit and edits a newsletter called LJR Great Lakes
Review. (The initials stand for Lynch Jones & Ryan, the firm that
now owns his company.) Don't bother trying to subscribe; it's for
market professionals like mutual-fund managers.
In our book,
"Dow 36,000," my co-author, Kevin Hassett, and I highlighted some
of Schlang's favorite stocks, touting them as the sort that prudent
investors should own. Between Sept. 1, 1999, when the book came
out, and Dec. 31, 2001, the benchmark Standard & Poor's 500-stock
index declined 12 percent, but all five of the Schlang stocks rose
— and the average increase was 34%.
The best performer
of his five, Landauer Inc. (LDR), has returned more than 50% since
last April alone — partly because investors finally noticed
that it dominated a small but critical business — making radiation-detection
badges for workers in nuclear power plants and the like. Often,
wallflowers blossom. Last week, Landauer graduated from the American
Stock Exchange to the New York Stock Exchange. The stock trades
at a price-to-earnings ratio of 20 — only a little below the
S&P average but still reasonable for such a sound, growing company.
Another of
Schlang's winners was RPM Inc. (RPM), which has soared since the
market bottom that followed the Sept. 11 attacks. RPM makes what
it calls "protective sealants" such as Rust-Oleum and Varathane.
Compared with semiconductors, cell phones and even life insurance,
those aren't very sexy products, but they have made a nice living
for RPM, whose earnings, Schlang expects, will continue to grow
at an average of 9% annually for the next three to five years. RPM
has also suffered in a slowing economy, but it continues to generate
loads of cash. Most analysts pay little attention to boring, Schlang-style
stocks (only two cover Landauer, for instance), but just last week
Merrill Lynch raised RPM's rating to "buy."
Schlang isn't
the only pro who prefers dull to shiny. Warren Buffett, probably
the most successful investor of the last century, has lately been
buying up companies like Benjamin Moore, which makes paint; Justin
Brands, boots; and Shaw Industries, carpets. Buffett's Berkshire
Hathaway Inc. has also purchased MiTek Inc., which is in the ultimate
dull business: building materials.
This is a
sector that analysts at the Value Line Investment Survey like as
well. They give three companies a ranking of "1" — putting
them among the 100 best stocks the research service covers. The
three are American Woodmark Corp. (AMWD), which makes kitchen cabinets
and vanities; Ameron International Corp. (AMN), manufacturer of
concrete and steel pipe, lighting poles and those ubiquitous protective
sealants; and Apogee Enterprises (APOG), which makes the outer skin
of nonresidential buildings. All the stocks have risen lately, but
they remain inexpensive in terms of price-to-earnings ratios. Ameron
trades at a P/E of 10; the others are in the mid-teens.
Among mutual
funds, Weitz Partners Value (WPVLX) is a successful prospector in
dull fields others often ignore. The fund has returned an annual
average of 19 percent over the past 10 years — an incredible
6 percentage points better than the S&P 500. Recently, in the pages
of my favorite newsletter, the irregularly published (and pretty
obscure) Outstanding Investor Digest, Wally Weitz rhapsodized about
Six Flags Inc. (PKS), a low-rent chain of theme parks (compared
with Disney, anyway). Weitz especially likes Six Flags because "in
a small- to medium-sized market, [a theme park is] something of
a natural monopoly." In other words, if you get to Kansas City first,
you'll have it all to yourself.
While most
of the stocks in your portfolio should be large, brand-name companies,
it's the smaller firms from the Great Unknown that make investing
fun. Don't simply look at the numbers; look at the business. Lately,
I have been obsessed with Gentex Corp. (GNTX), one of Schlang's
more recent finds. The company makes — get this — rear-view
mirrors. It has an 83% market share in the worldwide market for
automatic-dimming mirrors. These are specialty products, equipping
only about one-tenth of all cars, so the potential is huge. The
executives at Gentex figure that the rear-view mirror could be home
to all sorts of automatic controls, including an obstacle-detection
system, a built-in toll-paying pass and headlamp sensors. Microphones,
light-emitting diodes! There's a whole world on one of those mirrors,
and Gentex is building it.
Sales continue
to rise at a good clip, and the balance sheet is impressive. Gentex
has $192 million in cash, another $125 million in longer-term investments
and no debt. The stock rose by about one-fourth last year, but it
still trades far below its high of early 2000.
So dare to
be obscure. These small and mid-size companies will never become
giants, but that's the whole point. The fact that they're too boring
to be discovered frequently means that you can buy them on the cheap.
Of course,
the big question is whether some of these companies will ever get
discovered. Most of them will. An ironclad rule in investing is
that eventually the market recognizes good companies and bids them
to appropriate levels. But you have to be patient. "Eventually"
can be quite a while. Meanwhile, you'll have the intellectual satisfaction
of finding the Gentexes while everyone else is chasing the Intels.
—
Among the stocks and funds named, Mr. Glassman owns Hathaway and
is still thinking seriously about Gentex. His new book is The
Secret Code of the Superior Investor. This column
originally appeared in the Washington Post.
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