It's important for long-term investors to develop a guide for doing their investment research. Over the years I have developed questions to guide me in my thinking when researching the publicly traded universe. This represents a good starting point before doing more in depth research. Right now, let's talk about Genuine Parts Company (NYSE: NYSE:GPC).
1.) What does the company do?
When you buy shares in a company you effectively become part owner of that company. Therefore, it's important for an investor to understand what a company sells. Genuine Parts Company distributes automotive parts under the famous NAPA logo. It also distributes industrial parts under the Motion Industries name, which is well known in those circles. The company also distributes office and electrical supplies.
2.) What do the fundamentals look like?
Investors should look for companies that grow revenue and free cash flow over the long-term, retaining some of that cash for reinvestment back into the business and for economic hard times. Excellent revenue and free cash flow growth serve as catalysts for superior long-term gains. Genuine Parts Company is a slow grower, expanding its revenue, net income and free cash flow 42%, 56% and 36%, respectively, over the past five years (see chart below). The company benefited from an expanding economy. Fundamental expansion came from acquisitions as well as organic growth. I prefer to see organic growth as it serves as indication of increasing demand for the products.
Genuine Parts Company is doing ok so far in FY 2015. Its revenue, net income and free cash flow expanded 2%, 0.3% and 27%, respectively. Once again, acquisitions and organic growth contributed to the expansion in fundamentals.
Genuine Parts Company possesses a decent balance sheet. In the most recent quarter, the company possessed roughly $224 million in cash and equivalents, equating to roughly 7% of stockholder's equity. I prefer to see companies with cash amounting to 20% or more of stockholder's equity to get them through tough times and to self-finance initiatives.
I don't like long-term debt. It creates profit choking interest costs. I like to see companies with long-term debt amounting to 50% or less of stockholder's equity. In the most recent quarter, Genuine Parts Company's long-term debt amounted to only 15% of stockholder's equity. So far this year, the company's operating income exceeded interest expense by 58 times. The rule of thumb for safety lies at five times or more.
Genuine Parts Company has increased its dividend for 59 consecutive years and belongs to the dividend aristocrat list. I like to see companies pay out less than 50% of their free cash flow in dividends during a full year and retain the rest for other purposes. Last year, Genuine Parts Company paid out 50% of its free cash flow in dividends. Currently, the company pays its shareholders $2.46 per share per year and yields 3%.
Genuine Parts Company's solid fundamentals translated into good results for its shareholders over the last five years. Genuine Parts Company's total return amounted to 119% vs. 101% for the S&P 500 as a whole during that time (see chart below).
3.) How much management-employee ownership is there?
Investors should always look for businesses where the managers and/or employees own a lot of stock in the company. Managers with a great deal of stock in the company will take better care to maximize company profits, which will enhance share price and their personal wealth along with the wealth of shareholders. According to Genuine Parts Company's latest proxy no individual executive or employee directly owns more than 1% of the company. However, roughly 4% of the company is held in trust for the company's pension plan and a benefit fund under the stewardship of James Neill the Senior Vice President of HR and Carol Yancey, the Chief Financial and Accounting Officer. This means that the company's management wants to see the company succeed in order to keep these funds going.
4.) How does its "Report of Independent Registered Public Accounting Firm" stack up?
Every year a company employs external auditors to audit financial statements and evaluate whether it maintains adequate financial controls. At the conclusion of the audit, you want to see a letter from auditors with the language "unqualified" or "fairly presents", which generally means that the financial statements and internal systems in constructing them were clean or adequate. If you see "qualified" or "adverse" in the auditing letter's language then deeper issues in a company's financial statements may exist. Last year, Genuine Parts Company's auditors said the company maintained adequate internal controls and gave its financial statements a "presents fairly" opinion.
5.) What types of risk does it have?
It's always important for investors to weigh the various risks such as exposure to political risk in parts of the world where war is the norm, competitive positioning and market price risk. Genuine Parts does operate internationally, which means some political risk exists.
Genuine Parts Company operates in a competitive business. In the automotive parts business alone, it competes with companies such as Advance Auto Parts (NYSE: AAP), Autozone (NYSE: AZO), O'Reilly Automotive (NASDAQ: ORLY) and Pep Boys Manny Moe and Jack (NYSE: PBY). Genuine Parts Company resides in the No. 3 spot among the group in terms of absolute free cash flow generation (see chart below).
Amazingly, Genuine Parts Company's market price risk lies at par with the market. As of this writing, its P/E ratio clocks in at 18 vs. 18 for the S&P 500 as a whole, according to Morningstar.
6.) What does its forward analysis look like?
In the most recent quarter, Genuine Parts Company's management said that they will stay focused on strengthening the balance sheet and free cash flow, which represents a plus in my book. Financial prudence, selling a needed product such as automotive and industrial parts and a low valuation all add up to superior investment opportunity. This company definitely belongs in your portfolio.