Investors are willing to pay more for a company that holds the promise of growing its earnings. Even companies with unproven business models that can "sell a story" can often trade at high P/E multiples. Value investors, on the other hand, would rather not pay extra for earnings that are as yet unseen and difficult to predict. When the potential for increased earnings is offered for free, however, the price becomes right for even the stingiest of bargain hunters.
Consider Acme United (ACU), producer of measuring, cutting and safety products. Frequent visitors to the site will already recognize this company as a Stock Idea, due to its low P/E and high ROE. But what these financial metrics understate is the company's ability to grow its earnings.
Acme has set a goal of deriving 30% of its sales from products developed in the last 3 years. While this might sound quite reasonable for a hi-tech company with short product cycles and evolving customer needs, it is quite a challenge for a company that makes knives, pencil sharpeners and rulers such as Acme.
Nevertheless, the company is succeeding in this regard, attributing most of the 16% sales growth it realized in the last quarter to sales of new products. The company developed a non-stick coating that improves the performance of its line of blades, and thus saw increased sales of its iPoint pencil sharpeners and non-stick scissors.
Furthermore, sales of the company's 2008-developed utility knife with replaceable cartridges continue to grow. The company also recently acquired the patents and intellectual property of Camillus, and has recently launched a new line of Camillus cutting knives enhanced with Acme's high-performance titanium carbonitride coating.
What Acme has going on is not easy replicated. As Philip Fisher (whom Warren Buffett describes as inspiration for 15% of his investing philosophy) has written in his book Common Stocks and Uncommon Profits, stocks with the potential to be home-runs have special qualities which can result in spectacular returns. The company must have policies which promote newly developed products, the company's R&D must yield useful and viable findings, and the company must focus on the long-term. Acme appears solid across many of these points.
While value investors don't like to pay for growth, sometimes growth is offered in the market for free. With a P/E of 12 derived from earnings during a recession, along with a low net-debt to equity level, Acme appears to offer investors just that.
Disclosure: Author long ACU