As a smaller investor, it is tough to compete against all of the hedge funds, investment banks and large institutional investors of the world. One advantage you do have, however, is that your small size allows you to invest in some areas these larger investors can't. Although there are a number of smaller companies whose revenues and earnings don't ebb and flow with the market, these companies are often too small to make enough of a difference in large, multi-billion dollar portfolios and often these companies are overlooked and under-analyzed.
These following companies operate in unique industries which have properties that are often different from that of the rest of the market. Often these companies dominate a niche, enjoy outsized profitability and experience faster growth than the market as a whole. Adding a number of stocks such as these to your portfolio could help add a measure of diversification beyond what can be obtained by simply buying an index (although care should be taken to keep the position size of each investment small, or you'll add too much company related risk).
VeriSign is essentially the backbone of the internet. It operates the authoritative directory for all .com and .net sites as well as a number of smaller registries, providing the backend infrastructure which makes a large portion of the internet available. This means VeriSign directly benefits from the growth of the internet, specifically the number of sites. Although other companies operate .org, .biz, .info, .mobi and other registries, VeriSign operates with very little direct competition.
VeriSign is granted this monopoly by the Internet Corporation for Assigned Names and Numbers, or ICANN, through the DOC, which is renewed periodically, most recently in 2012 until November 2018. It seems unlikely this task would be reassigned to a new operator as VeriSign has had no periods of downtime, and it would be highly likely that a new operator would run into hiccups during a transition, costing online businesses significant revenues during any blackouts.
VeriSign is extremely profitable, with operating margins growing to over 54% in the most recent quarter. Revenues have consistently grown double digits, even through the recession, with earnings per share growing faster due to operational improvements and share repurchases. Although a bit pricey at over 20 times earnings, VeriSign's fast growth and competitive advantages may make this a winner over the longer term.
Compass Minerals (CMP)
Investors in Compass Minerals have the rare ability to thank the weatherman for bad weather. With the largest portion of sales coming from highway deicing salt, this company sells a product that is almost completely unaffected by economic cycles. The tradeoff is that they are dependent on snowfall levels in the US and Canada.
This business has attractive economics, as salt has a low cost yet essential nature. Because of its low cost per unit weight, shipping is a large portion of the total cost, making most markets localized in nature. The local nature of competition makes each market an oligopoly, leading to relatively stable prices with regular price increases averaging about 3% per year. Compass is in a good position in this market, with roughly 30% market share in the North American and UK highway deicing markets.
The Consumer and Industrial, and Specialty Potash segments constitute the remainder of the company's revenue. Consumer and Industrial salt volumes tend to be fairly stable throughout the economic cycle as well, and help to dampen the effect of weather-related volume changes. Specialty Potash is also an attractive business to be in as it is also essentially an oligopoly, although pricing can and does change more rapidly because of changing conditions in agricultural end markets.
Compass's valuation seems excessive due to unseasonably good weather and a few one-time costs (such as a tornado recently hitting a mine, increasing costs in the short term), but if you look over a longer historic time-frame, it seems to be at a reasonable price. With just under a 3% yield which should grow nicely over time, this is worth putting on your wish list.
Iconix is in the licensing business. Instead of designing, manufacturing and distributing clothing and other items to retailers, Iconix outsources all of these tasks and simply licenses out their portfolio of brands to a wide range of retailers, often with exclusive agreements with guarantees of minimum licensing revenues over a period of years. This strategy means that a large portion of revenue is turned into cash, with roughly half of the last 3 years' revenue turning into free cash flow.
Iconix's strategy involves retaining this cash, purchasing new brands and then licensing those out, which has effectively diversified their dependence on any 1 retailer (Wal-Mart is the biggest source of revenue at 17%). Recently the company has branched out and purchased non-clothing based IP, such as Peanuts and Sharper Image. The Peanuts acquisition shows a lot of promise, with a movie deal slated for 2015 which should bring in additional revenue and maintain the brand's already impressive longevity.
Iconix has had an incredible run recently, up about 85% over the last year but still appears to be somewhat reasonably valued at only 18 times earnings and roughly 11 times free cash flow (a large portion of expenses are the amortization of intangible assets, aka brands, which don't affect cash flows). If you believe that management can continue finding new opportunities at reasonable prices, Iconix has the potential to be a homerun growth stock over the long term.
Sysco is the largest (and only publicly traded) foodservice distributor, serving about 18% of the food-away-from-home market. Although this industry is generally known for its slim margins, Sysco's significant economies of scale has allowed them to operate more efficiently than their competition, earning an average ROE of over 26.8% over the last 5 years.
Since most customers are on contracts where they are charged the cost of the food plus a margin, Sysco actually benefits directly from periods of mild inflation (although rapid inflation can keep customers from eating out, leading to decreased volumes). This gives Sysco's stock a natural inflation fighting power, helping to grant its holders positive real returns.
The company's earnings have been hurt lately as the foodservice industry is still experiencing negative business conditions with less people eating out since the recession, pressuring sales and gross margins. Also affecting earnings in recent years has been a multi-year restructuring to move to a new ERP system, although this has the potential to deliver meaningful cost savings down the line. ERP costs, combined with a few more minor factors, have reduced the company's earnings from $2.14 to $1.67 for the year ending June 2013. These pressures on earnings have caused the stock price to languish, presenting a possible buying opportunity. With roughly a 3.5% yield which should grow faster than inflation, Sysco seems like a good choice for income investors.
Copart is one of the largest auctioneers of salvage vehicles, operating as a duopoly with KAR Auction Services (KAR) with Copart and KAR controlling 70% of the market, with a roughly equal split between them. Auctions generally offer attractive economics to the company managing it, as this business model benefits from network effects with buyers wanting to buy where there are the most sellers and sellers wanting to sell where there are the most buyers. This is reflected in Copart's operating margins between 27% and 30%, and ROE between 23% and 30% over the last 3 years.
The salvage auction market is attractive for a number of reasons. First, it is relatively unaffected by economic cycles as the number of salvage cars auctioned is more correlated with the number of miles driven than the sales of new cars, a figure which varies little from year to year. Second, only 3.5 million of the 12 million cars deregistered each year are auctioned, which leaves room for market share gains from the non-auctioned portion of the market. Also, since auction revenue is often a percentage of proceeds Copart's revenue will grow along with general automotive inflation.
Copart has also made efforts to grow outside of the US, with UK revenues representing a sizable part of revenue and acquiring operations in Brazil, Germany and Spain in 2013 (although non-US, non-UK revenues are still a small portion of total revenue). Copart has also been able to supplement internal growth by acquiring operations of smaller US and UK companies, leading to revenue growth averaging 11.2% per year over the last decade. Although pricey at 23 times earnings, Copart is worth adding to your watchlist as a pullback would make this an attractive addition to a growth oriented portfolio.