Finding Investments in Your Own Backyard

Includes: FAST, MDT, STJ
by: Ben Marks

Anyone who has grown up in suburban America can remember one of those long summer vacation days, complaining to your parents about being bored, wanting to go someplace more exciting. My father's standard response was that you just haven't explored your own neighborhood enough.

Today my dad's advice is a simple, sound alternative to the popular viewpoint among financial commentators and experts that investors nowadays must focus on investing outside of America to chase greater gains. Financial advisors and their clients would do well to explore the benefits of investing in local and regional equities, such as:

  • Distinguishing one's self from the pack: Advisors whose practice incorporates a high familiarity and focus on local and regional public companies can differentiate themselves as providers of truly customized asset management solutions for the investors they serve, vs. advisors who offer more "off the shelf" recommendations.
  • Greater investing transparency: As a rule of thumb, access to information on a timely basis is key to investing success. One of the benefits to investing in local equities is the increased transparency, as local and regional press tend to discuss and analyze area public companies frequently.
  • Potential "best of both worlds" returns: When a locally oriented portfolio has exposure to regionally headquartered companies with a global reach, this can create a "best of both worlds" outcome with potential for strong and stable returns, as well as better access to information and added emotional satisfaction.
  • Emotional assurance and satisfaction: A notable benefit that cannot be calculated in quantitative terms is the peace of mind retail investors derive from investing in what they know, and their satisfaction in supporting their local economy
  • Potential popular reactions to current prevailing sentiments among the experts: As people both within and external to the United States continue to regard America as being "down and out" in terms of future prospects, there may at some point be a strong backlash at the grassroots that manifests itself in an "invest in America" movement. History certainly does not rule out this possibility.

How would one construct such a portfolio? If we assume that one of the key drivers behind a localized investment strategy is added peace of mind, then it makes sense to orient such a portfolio around a "boring but profitable" approach.

The first step is to identify a key "anchor industry" for the region in which you are based. Each region has at least one. For example, residents of the Pacific Northwest or Northern California would identify technology, whereas Texas and Oklahoma investors could target energy.

Once you have established what the anchor industries are, target the two to three bellwether companies that have helped to spawn that industry. Key attributes to look for are:

Market cap in excess of $5 billion

  • Reasonable valuations, based on estimated future price-to-earnings (P/E) ratios relative to projected earnings growth, and compared against historical valuations for the company and its peers
  • Strong balance sheet, with low debt ratios relative to peers, high quality ratings on debt, meaningful cash reserves and low borrowing costs executive management
  • High-quality team, taking into account tenure with the company, credentials, industry experience and ability to articulately communicate their vision to the investing public
  • Dominant market position as a No 1 or 2 player in its space
  • Diversified revenue streams based on a strong product mix.

Let's apply the above approach to some concrete examples. Our firm is based in the Greater Minneapolis area, which is a hot bed for the medical device industry. Two locally based companies worth looking at in this industry are Medtronic (NYSE:MDT) and St. Jude Medical (NYSE:STJ).

As of the end of September both Medtronic and St. Jude Medical have sizable market caps-- $36 billion and $13 billion, respectively--and satisfy all of the above key criteria. These make excellent "anchor company" candidates for a local/regional investing portfolio for where we are based.

If I lived in Texas, where there is a concentration of energy-related companies, I would consider a company such as natural gas producer El Paso Corp (EP) as my "anchor company."

Investors in Northern California or the Pacific Northwest can choose from a bevy of major technology players that were the founding fathers of Silicon Valley. Chip maker Intel (NASDAQ:INTC) and networking giant Cisco Systems (NASDAQ:CSCO) both fit the above criteria to a tee.

High Growth Small/Mid Cap Investments

From there, and depending on the time horizon and risk appetite, consider identifying the three to five ancillary companies within that industry that are also in your region and appear positioned to capture a strong potential market niche. Clearly the financial profile for this segment of companies is not the same. Additional attributes to look for are:

  • Potentially significant market size in terms of demand for the company's offerings
  • Strong market position relative to competitors.
  • Robust pipeline of products, based not just on company announcements but regulatory or other mandatory disclosures.
  • Significant "skin in the game" in terms of management equity ownership.

A solid example of one of our local names that epitomizes what makes Midwestern companies compelling investments is Fastenal (NASDAQ:FAST). This boring but reliably growing purveyor of nuts, bolts and other industrials products has helped support the medical device and other industries.

Fastenal has rewarded investors well over the years through savvy management, shareholder-friendly corporate governance and conservative financial management. As with any investing strategy, there are pitfalls. Perhaps most importantly, advisors and their clients should recognize that there is no substitute for good fundamental analysis.

Just because an investor knows of a local or regional company--and may even have friends and family working there--that doesn't make it a "safe" investment. Along these same lines, any small- cap or "development-stage" company carries inherent, increased risk, regardless of how many cars you see in the parking lot every day.

Observing the events of the past few years has formed a personal conviction that today's investors highly value three things: transparency, liquidity and proximity. They seek more readily available information; they want their investments to be in high-quality securities that have daily pricing and can be easily sold; and they desire to be closer to both the companies they invest in and the people who make those investment decisions.

Overlay these imperatives with the intrinsic sentiment that Americans have for supporting their local communities, and advisors and clients could have a winning investing strategy right in their own backyards.

Disclaimer: The information set forth herein has been derived from sources believed to be reliable, but is not guaranteed as to accuracy and does not purport to be a complete analysis of the securities, companies or industries involved. Opinions expressed herein are subject to change without notice and are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. To determine which investments and strategies may be appropriate for you, please consult with Marks Group Wealth Management or another trusted investment adviser. Stock investing involves market risk including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Past performance is no guarantee of future results.