Some of the best investment ideas may be found in relatively small companies that provide needed products. As such, you may want to consider companies whose market capitalizations lie in the small-cap range -- i.e., with values between $300 million and $2 billion. Of course, when researching companies in that range it becomes even more important to consider company fundamentals. Increasing revenue, net income, and cash flow as well as a solid balance sheet all serve as catalysts for superior long-term gains. Let's take a look at three companies to see if they fit the bill for solid fundamentals.
A Parts Supplier
Dorman Products (NASDAQ:DORM) supplies auto parts in the automotive aftermarket to companies such as AutoZone (NYSE:AZO), Advance Auto Parts (NYSE:AAP), and O'Reilly (NASDAQ:ORLY). Some of Dorman's brands include Help!, TECHoice, AutoGrade, and Conduct-Tite!. Over the past five years, Dorman Products has increased its revenue, net income, and free cash flow 76%, 209%, and 87%, respectively (see charts below). These increases translated into a total return of 538% for Dorman shareholders vs. 113% for the S&P 500.
Penny pinching during challenging economic times led to customers holding on to their cars for an average of 11 years, increasing their need for parts and driving top-line growth for Dorman Products. Moreover, cost control, product innovation, higher margins on new products, and lower interest costs contributed to net income and free cash flow growth over the past five years.
Year to date, Dorman Products saw its revenue and net income increase 20% and 22%, respectively. Strong demand and innovation contributed to these results. However, free cash flow declined 77% due to an increase in capital expenditures vs. the same time last year. It should be noted that increased pricing pressures and increased provisions for inventory obsolescence made an impact on gross margins, which decreased from 39.5% in 2013 to 38.1% in 2014. Investors should keep an eye on this development.
Currently, Dorman Products sits on an OK balance sheet with a cash balance of $54 million, equating to 12% of stockholder's equity. The company possesses no long-term debt, which is a good thing since interest on long-term debt can choke out profitability and cash flow. Investors should always look for companies with long-term debt-to-equity ratios of 50% or less. Currently, the company pays no dividend.
An Egg Company
Cal-Maine Foods (NASDAQ:CALM) represents the largest producer and seller of shell eggs in the United States. The company maintains 32.4 million "layers," or chickens that lay eggs. In addition to ordinary eggs Cal-Maine sells specialty eggs, which made up 24% of its revenue in 2014. Cal-Maine believes it provides for 23% of American egg consumption, according to its 10-K.
Over the past five years Cal-Maine's revenue and net income increased 58% and 61%, respectively (see charts below). However, free cash flow declined 33% during that time. Cal-Maine's shareholders saw a total return of 184% vs. 113% for the S&P 500 total return index. Factors such as favorable price increases, acquisitions, and increased volume contributed to the increases in revenue and net income. A spike in capital expenditures in 2014 contributed heavily to the decline in free cash flow during the past five years.
Currently, Cal-Maine sits on a rock solid balance sheet with cash and short term investments of $209 million, equating to 35% of stockholder's equity. Cal-Maine has $51 million in long-term debt, which equates to a mere 9% of stockholder's equity.
Cal-Maine does pay a dividend. When gauging dividend sustainability, investors should look at how much free cash flow a company disburses in dividends. Investors should look for companies that pay out less than 50% of their free cash flow, ensuring that they hold on to enough cash to sustain the business. Last year, Cal-Maine paid out 38% of its free cash flow in dividends. The dividend rate varies from year to year as the company harbors a policy of paying out 33% of its net income. In 2014, Cal-Maine paid its shareholders $2.36 per share, yielding 3.2%.
A Brand That Speaks for Itself
WD-40 (NASDAQ:WDFC) is best known for its can of multi-purpose lubricant. It also sells other household items such as 2000 flushes, Carpet Fresh, and Spot Shot. Over the past five years WD-40's revenue, net income, and free cash flow increased 26%, 52%, and 54%, respectively (see charts below). WD-40 shareholders saw a total return of 172% vs. 113% for the S&P 500 total return index.
Its namesake lubricant portfolio served as the catalyst for increases during this time. Other household items served mainly as "harvest brands" that helped fund the company's strategic initiatives. This trend has continued into 2014 with sales of the multi-purpose products line increasing 6% so far, contributing to a 4% overall increase in revenue and a 2% increase in net income. However, increased capital expenditures contributed to a 49% decline in free cash flow.
WD-40 sits on a rock solid balance sheet with its cash and short-term investments balance of $90 million equating to 51% of stockholder's equity and no long-term debt. Last year, WD-40 paid out 39% of its free cash flow in dividends, which is in the sustainable range. Currently, the company pays its shareholders $1.36 per share per year and yields 1.8%.
Dorman Products, Cal-Maine Foods, and WD-40 represent companies that sell needed products and sport solid fundamentals. You shouldn't expect them to go bankrupt anytime soon. Looking at their valuations, Dorman Products, Cal-Maine, and WD-40 trade at P/E multiples of 17, 16, and 25, respectively vs. 18 for the S&P 500. This means that Dorman Products is fairly valued, while Cal-Maine is undervalued and WD-40 is overvalued. All three deserve a spot in your portfolio; just make sure to take advantage of any temporary price corrections that might make good entry points.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.