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A Big Brand in a Small Package

For many investors (including myself) it is often difficult to go about seeking attractive brands that have exceptional characteristics - not because they are rare and difficult to find but because so many are often hiding in plain sight. It is hard, though not impossible, to purchase shares in companies, which own "obvious" brands (such as Coca-Cola (NYSE:KO)) as their virtues are readily understood by many investors, reducing the possibility of an undervalued situation.

Sometimes it is possible for investors to discover a few brand opportunities in the more obscure regions of the market. In an earlier article of mine, I discussed the attractive qualities of B&G Foods (NYSE:BGS) - a company that owns a collection of niche brands in the retail foods sector. Despite the fact that the company only has a market cap of $1.5 billion, it has been able to both grow its dividend and earnings power at a robust rate and by virtue of its obscurity provides the potential to be a more attractive purchase than its giant blue-chip cousins.

The WD-40 Company

Another company that I believe offers similar investment prospects - that of brand value, small size, growing earnings and dividends - is the WD-40 Company (NASDAQ:WDFC). With a market capitalization of $865 million, the WD-40 Company is small. But despite its small size, its flagship product, WD-40, is world famous as an extremely useful product. In addition to its flagship brand, the company's portfolio also includes Lava Soap, a type of heavy duty soap embedded with pumice, 3-in-1 Oil and several other brands.

I believe that these types of products are naturally inclined to intrinsically attractive economics. All of these products need to be purchased over and over again by consumers and WD-40 in particular has a myriad of uses. Any consumable product that can be used for many different things is very appealing to me. I also believe that WD-40's brand portfolio will grow organically with the population and will continue to be relevant when one needs to guard against rust, oil a squeaky wheel or get clean after doing a dirty job.

A Thought Experiment on Pricing Power

Pricing power is another attribute that I believe is a cardinal virtue of name-brand products. Bear with me as I postulate a thought experiment, which I use as a test to evaluate brand strength:

Millions of people the world over have WD-40 in their garage, closet or pantry. It's just sitting around collecting dust and gets replaced once every few years. Let's say you had to go to the store and buy a new bottle because you needed to fix a squeaky hinge on your bedroom door. How much would you expect to pay for a regular size bottle of WD-40?

If you don't know the number right off of your head, that's the kind of pricing power I'm talking about and the kind investors are looking for. The company selling it has the freedom to set the price and to raise it at their will. Of course, I do not believe that price gouging is good for business in the long run, but the freedom to raise the price of a product is a sign of its strength and durability. Now that I believe I have established the merits of WD-40 and its brands, the only thing left is to look at the balance sheet of the company.

The Numbers on WDFC

Currently priced at $56.91 per share against $4.88 of cash and $11.86 of book value, investors are paying a substantial premium for the company currently, something very understandable given the premium towards brands in the marketplace. With an annual dividend currently yielding 2.18%, and a payout ratio under .50 - WDFC both returns money to investors while retaining a healthy portion of its earnings, which it can reinvest in acquiring new brands or repurchasing its stock - something which it has done in the past several years and has authorized for in 2013. In addition, the company has insider ownership a little north of 5% - and though that is not a large amount compared to some other companies that I cover it is encouraging to see.

Slide 28 of the 2013 investor presentation, which can be found on the company's website is also particularly interesting, where the cost of a can of WD-40 is broken down - with 40% of the total cost per unit tied to the price of petroleum products, providing potential for margins narrowing if the cost of petroleum products declines - a possibility given the shale-gas boom in the United States.

I believe that because of brand strength, a history of dividend growth and a strong balance sheet that WDFC is a compelling buy. However at current levels I believe that investors are best served by watching and waiting - if the price of the company's shares decline on broader market volatility and the dividend yield crests 2.5%, I will be a buyer as I believe this company meets the Buffett criteria for an "Equity-Bond," or in other words, a stock that has a proven capacity to generate higher earnings over time through competitive advantage and offers investors an "expanding coupon" of dividend payments. I also think that because of these characteristics. WDFC is a prime acquisition target given the small size of the enterprise and strength of its main brand.

Patience is a virtue and I'm eagerly waiting for a good entry point on WDFC.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.