TCS Daily


Dare to Be Obscure

By James K. Glassman - January 23, 2002 12:00 AM

One 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. (symbol: 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 percent 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 percent -- 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 percent.

The best performer of his five, Landauer Inc. (LDR), has returned more than 50 percent 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 percent 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 percent 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.

Originally published in The Washington Post
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