ServiceMaster Serves Cash

When Motley Fool Income Investor chief analyst Mathew Emmert selected ServiceMaster (NYSE: SVM  ) for subscribers he wrote that it was "right under the noses of most investors." What he meant was that the company deals in businesses many of us see or use regularly -- from Terminix pest control to TruGreen and ChemLawn landscaping service to Rescue Rooter's plumbing service. What neither he nor any of us could have predicted is that fourth-quarter earnings, released last week, would provide such a sweet fragrance.

Indeed, most everything came up roses for ServiceMaster. All five of the company's business units reported sales gains for the quarter and full year. Net income for all of 2004 was up 9% year over year after adjusting for a $150 million tax benefit and a $480 million one-time impairment charge taken during 2003. The company said it expects sales to grow in the mid-to-high single digits during 2005 and earnings to grow slightly faster than that. Cash flow from operations should still exceed net income.

Problems remain, of course. For example, roughly 57% of the company's total balance sheet assets are intangible. I prefer firms that have plenty of cash and goods that can be liquidated in the event of trouble. I also find it a little disconcerting that this diversified company is seeing a majority of its earnings growth coming primarily from two businesses: the TruGreen lawn care unit and American Home Shield warranty services unit.

Still, there's a reason superinvestor Warren Buffett has invested in ServiceMaster. I'm no mind reader, but I'll bet cash flow has a lot to do with it. The firm boosted its structural free cash flow, or what Motley Fool Hidden Gems chief analyst Tom Gardner has come to call owner earnings, by more than $500 million over last year. That's an astounding improvement that can lead only to good things. You know, little things such as higher dividends, lower debt, and generous share buybacks.

ServiceMaster is already up more than 18% since Mathew first recommended it last May. Can gains continue at that pace? No, probably not. But I find the prospect of reinvesting dividends in shares of a rapidly improving business attractive even at $14 per share. That could be because I've made the mistake of running away from an improving business too early when I held Caterpillar (NYSE: CAT  ) for my wife's account. Or it may be that in years of investing I've come to realize a simple truth: Good companies with steady cash flows are rarely available at good prices. In that sense, ServiceMaster is about as good as it gets.

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Fool contributor Tim Beyers was dismayed to find out that ServiceMaster was under his nose, too. Oops. Where are you searching for stock ideas? Share your thoughts with other Fools at the Foolish Collective discussion board. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking Tim's Fool profile, which is here. The Motley Fool has a disclosure policy.


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