Opportunities abound off the beaten path

Dollars & Sense

September 08, 2002|By Pat Dorsey | Pat Dorsey,MORNINGSTAR.COM

When I started investing, one of the hardest things for me was deciding which stocks were worth the effort to investigate. After all, analyzing a stock takes a lot of time, and several thousand are out there, so it was tough to know where to start.

To make things worse, most financial magazines tend to pitch the same names over and over again, even though some of Wall Street's best ideas are in off-the-beaten-path areas such as insurance brokerage and orthopedic implants.

So here's a shortcut to some of the best businesses you might never have heard of. Most of them are not small - only two are below $2 billion in market capitalization - but they mostly inhabit lesser-known areas of the market. Many of these are not cheap enough to buy now, but they all deserve a place on your watch list, so start learning about them now so you're comfortable enough to buy them when they do sell off.

Cintas (CTAS): Although the uniform-rental industry doesn't make for great cocktail-party chatter, it does make plenty of money. Cintas consistently turns in returns on equity in the high teens and sports operating margins of about 17 percent, thanks to its ability to keep competitors at bay with a huge national distribution network.

Robert Half International (RHI): Returns on invested capital of about 25 percent make Robert Half worth watching. The firm's strong brand name and focus on high-end temporary staffers in areas such as law and accounting have given it a track record that few competitors can match, and a rock-solid balance sheet gives it a firm financial foundation.

Danaher (DHR): Who knew that making process-control equipment and Craftsman tools could be so profitable? Danaher has generated great free cash flow and a tremendous track record of solid returns with a simple strategy: Buy small industrial businesses and make them more profitable than they used to be.

DST Systems (DST): If you own a mutual fund, the odds are good that DST does some of the back-office work and record-keeping for your account. As the fund industry grows, so does DST, and, because data-processing businesses tend to become more profitable as they spread fixed system costs over bigger sales bases, DST is likely to become even more profitable.

Biomet (BMET): This is one of the leading manufacturers of hip-replacement and other joint-replacement products. With baby boomers getting older and staying active, and with the first wave of joint replacements from the 1980s starting to wear out, demand for Biomet's products should stay strong enough to maintain the company's high-teens return on capital. Gross margins of 70 percent don't hurt.

Expeditors International (EXPD): The freight-forwarder business is doing quite well. Unfortunately, the shares still aren't low enough for me to get excited about. You can't have everything.

Moody's (MCO): What a lovely, lovely business this is. Moody's is one of the two big kahunas in the bond-rating industry, and it essentially splits 80 percent of it with Standard & Poor's, a unit of McGraw-Hill (MHP). Rating bonds is great work if you can get it - the business isn't asset-intensive, and the barriers to entry are quite high. You'll have to wait for Moody's stock to decline quite a bit until it's attractive, though.

Concord EFS (CEFT): This company is a lot like DST, a boring data processor with a very profitable business that has tremendous operating leverage. Concord has a big share of the automated teller machine and debit-card processing markets, so as long as people keep withdrawing cash and paying with debit cards, the company should continue to grow at a nice clip. The shares are reasonably priced, though not a real bargain, at $23.

Markel (MKL): This niche insurance company has been mentioned here before, but I thought I'd give it another moment in the limelight. Analyst Aaron Westrate calls it "one of the best insurers we've ever seen," and it's not hard to see why: Markel has compounded its book value per share at 22 percent annually over the past 10 years, and it generates consistent underwriting profits.

White Mountains Insurance (WTM): This is another smaller insurance company with an impressive pedigree: Industry legend Jack Byrne, who was responsible for GEICO's turnaround in the 1970s, is chairman and owns 14 percent of the company. (To drop another name, Berkshire Hathaway (BRK.B) owns another 17 percent.) White Mountains scoops struggling insurers out of the bargain bin, turns them around, and then sells them for a large premium to the original purchase price. It's a strategy that has made shareholders plenty of money.

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