TCS Daily


Dull, But Worthy

By James K. Glassman - February 17, 2005 12:00 AM

In 1996, a couple of marketing professors named Thomas Stanley and William Danko transformed some startling research on the habits of America's wealthy into a big bestseller called "The Millionaire Next Door." They found that, unlike Donald Trump, most millionaires live with modesty and prize frugality and that, unlike Bill Gates, they made their money from boring businesses in quiet niches.

In the book's appendix, the authors provide a list of popular millionaire occupations. Among them: owning ambulance services, cafeterias, funeral homes, mobile-home parks and meat-processing plants. The very rich head companies that control pests, distribute wholesale groceries, offer tug-boat services and manufacture curtains.

"Typically," write Stanley and Danko, "it's...mundane categories of businesses that provide wealth for their owners. Often dull-normal industries don't attract a great deal of competition, and demand for their offering is not usually subject to rapid downturns."

There's an important lesson here for investors in stocks. As a shareholder, you should always think of yourself as an owner, or a partner, in a business. "Focus on companies, not stocks," writes one of my favorite sages, H. Bradlee Perry of Babson Capital Management. The businesses that produce American millionaires deserve your attention. Dull, in other words, is good.

Of course, dullness is in the eye of the beholder. There's no definition, no Mundane 500 Index to track. My strong suspicion, however, is that, over the long run, stocks of companies in dull businesses have outperformed stocks of companies in sharp ones.

What's dull? A business that's so unattractive that it wouldn't merit more than a quick glance if you saw a headline about its Initial Public Offering. For example....

        "Sawdust Firm Issues Stock"

        "Maker of Moderately Priced Pants Goes Public"

        "IPO for Small-Truckload Carrier in Fort Smith, Ark."

Do any of those pique your interest? If so, you may have a future in the exciting world of unglamorous investing.

Actually, all three of the companies in the fictitious headlines above are components of the model portfolio of The Prudent Speculator, the financial newsletter with far and away the best record for stock-picking over the past 10 years (up an annual average of 25 percent), according to the scorekeepers at the Hulbert Financial Digest.

The companies are: Pope & Talbot, which turns sawdust and wood chips into fiberboard and has enjoyed sharply higher earnings in the past year as commodity prices have soared; Haggar, the successful pants maker; and Arkansas Best, a well-managed trucker that's ranked "1" (tops) by the Value Line Investment Survey and trades at a PEG ratio (P/E divided by projected earnings growth rate) of just 0.77 despite rising more than 40 percent last year. A stock with a PEG ratio below 1.00 is generally considered a bargain.

Another source of mundane prospects is the Focus List put together by analysts at Raymond James & Associates, the low-key St. Petersburg, Fla.-based investment firm with a sensational track record for stock picking. The November list includes Briggs & Stratton, which makes air-cooled engines for outdoor power equipment like lawn mowers, and Masco, which makes insulation and other building products. Briggs & Stratton has returned 21 percent, including dividends, over the past 12 months and trades at a forward P/E of 11; Masco, which has returned more than 30 percent, has a dividend yield of 2 percent and a forward P/E of 14.

Not only do dull business sectors avoid flocks of competitors, they also tend to be undervalued by the stock market.

That makes perfect sense when you consider Efficient Market Theory, the idea, made popular by economist Eugene Fama in the 1960s, that today's stock prices are determined by swarms of investors using the best current information. With a stock like Microsoft or General Electric, there are so many professionals buying and selling that it's a good bet the price is highly efficient, or accurate. In other words, you're unlikely to beat the Street by investing in a portfolio composed of well-known stocks.

GE is a stock for what I call "partakers" -- investors who want to participate in the rise in the company's value over many years. Bargain hunters need to search elsewhere -- especially for wallflowers. These are stocks that fail to seduce, not because they don't make solid profits and have sound balance sheet, but because they aren't in sexy businesses.

As a result, many wallflower stocks are priced inefficiently -- often too low. Such anomalies really do exist, even in a generally efficient market. As Warren Buffett wrote to his Berkshire Hathaway shareholders in 1988: "Observing correctly that the market was frequently efficient, [academics and Wall Street pros] went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day."

If the market were always efficient, Buffett wouldn't be worth $41 billion.

In the long run, boring stocks with good fundamentals get discovered, and investors in them get rewarded as they prices shoot up. "In the short run, the market is a voting machine," wrote Benjamin Graham, one of the financial geniuses of the last century, "but in the long run, the market is a weighing machine." In other words, stocks eventually get priced according to what they are really worth, their true weight. Patience pays.

My favorite hunter (and finder!) of mundane beauties is Elliott Schlang, who runs the LJR Great Lakes Review, a research service that highlights investment prospects for big financial institutions. Schlang lives in Cleveland and generally stays out of sight, like the companies he favors.

He keeps only about 30 stocks on his list at a time, and they include such names as Littlefuse, a company based in Des Moines, Iowa, that makes circuit protectors used in cars, trucks and machines, and Dentsply International, which sells false teeth and dental supplies. Littlefuse is up 30 percent in the past 12 months, but it's still below its price of five years ago. Dentsply's earnings have been rising in what I call a Beautiful Line, from 13 cents a share in 1990 to an estimated $2.35 this year.

Among Schlang's recommendations, mundane all:

  • AptarGroup: Up by 50 percent in the past year, Aptar is the world leader in "dispensing systems" -- that is, aerosol valves, caps, closures, and pumps for face creams and the like. Schlang and his colleague Gregory Halter are especially fond of Aptar's propensity to boost its dividend, which has risen an average of 16 percent annually over the past five years.
  • Matthews International: This Pittsburgh-based company makes cast-bronze memorials, mausoleums, caskets and cremation supplies. It's a business that will never go out of style. Shares are somewhat pricey for a dull company (a forward P/E of 18) but growth has been consistent and brisk.
  • Lancaster Colony: Here's the apotheosis of the humdrum. Its main business is specialty foods of the least exciting sort. Vegetable dips, croutons, and Amish Kitchen premium dry egg noodles are a few examples. Lancaster also gets a fifth of its revenues from candles, glass tumblers and bowls and another fifth from automotive products like aluminum steps and toolboxes for pickups and vans. A boring conglomerate if ever there was one! But I don't mean to mock. Lancaster raised its dividend on Nov. 15 for the 42nd year in a row. It trades at a forward P/E of 17 with a yield of 2.3 percent.

Like most successful stock-pickers, Schlang concentrates on what he knows best: small-to-medium-sized unsexy businesses in the Midwest. My favorite mundane mutual fund is more diversified than the Schlangian portfolio by market cap but not by geography: Mairs & Power Growth mainly owns shares of companies based in Minnesota, home of both the fund itself and of public radio's "A Prairie Home Companion," so don't expect anything flashy.

Top holdings include such boring companies as Pentair, which sells water-treatment equipment and enclosures for machinery; Donaldson, air filtration systems; Graco, lubricant dispensers (the company also makes machines to paint lines on highways); Bemis, flexible packaging; Valspar, paints and coatings; and H.B. Fuller, adhesives.

Talk about dull! The manager, William Frels, rarely sells a stock. Turnover, according to Morningstar, is an astoundingly low 2 percent a year (compared with about 100 percent for the average fund).

The Rip Van Winkle style works brilliantly. The fund ranks in the top 1 percent of its category (large-cap, with a blend between growth and value stocks) for returns over the past three-, five- and ten-year periods. For the 10 years ending Dec. 1, 2004, Mairs & Power returned an annual average of 18 percent, compared with less than 12 percent for the benchmark Standard & Poor's 500-Stock Index. For the past five years, the fund beat the S&P by an average of 14 percentage points annually.

All this, with an expense ratio of just three-quarters of a percentage point a year.

So where has Mairs & Powers been all your life? In much the same obscurity as the kind of stocks it owns.

A version of this article appeared in Kiplinger's.

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