5 Companies Set to Dominate Competitors

Far too many of the gigantic companies that failed in our recent economic meltdown shared the same problem. They lost sight of their core businesses and instead focused way too much on complicated financial engineering. In many cases, they were lured by the siren song of "significant extra profits with very little apparent risk" from derivatives and excess leverage.

As should be apparent from the sheer number of huge businesses that failed as the credit market dried up, that was a very tempting siren song, indeed. What made the siren song so alluring was that it played to large companies' key strengths: scale and diversification.

From billions to pennies
You see, as a company gets big, it can start taking advantage of its size. It gets better pricing on its raw materials thanks to its scale and better terms on its loans thanks to its large cash-generating abilities. As its offerings grow over time, the chances are that its products will not all follow identical revenue cycles, and that diversification will make its operations seem less risky.

That is wonderful for the company and its investors, up to a point. And that point is when the company starts thinking of ways to leverage its newly found muscle through fancy financial engineering. When that happens, the company opens itself up to the kind of excessive leverage that brought down Fannie Mae (NYSE: FNM  ) , Lehman Brothers, and Bear Stearns.

After all, it's really only a small step from financial engineering to the kinds of esoteric spreadsheet-based models that "can't possibly fail outside of a black swan event." Look what happened to General Electric (NYSE: GE  ) . What was once the world's largest company -- known for its industrial products from light bulbs to locomotives and turbines -- was nearly taken down by its finance arm's aggressive lending.

The advantages of staying nimble
A critical factor in the meltdown was excessive debt, or "leverage" as the financial engineers like to call it. When investments work out in favor of a company, that debt magnifies the impact of the returns the company's stockholders see. Leverage looks brilliant when things are going well, but it's a knife that cuts both ways. When an investment turns against a heavily leveraged institution, even a small and otherwise manageable loss can wipe out equity almost instantly.

If a company didn't leverage itself to the hilt, however, it missed out on the magnification effects from the bubble -- and its burst. While the upside may not have appeared nearly as sweet, the downside became survivable. In addition, with a clean balance sheet that helped mute the impact of the crash, that company is now nimble enough to take advantage of the gaping holes left by its failing, overleveraged competition.

How did some avoid that siren song?
Part of what made the initial leverage so tempting to companies was the relentless drive for growth that comes from being publicly traded and subject to Wall Street's pressures. Wall Street can be a very difficult pressure to ignore, because large institutional shareholders can force changes to a company's board and management team.

But if a company has a significant amount of insider ownership, that pressure is easier to resist. High insider ownership reduces the influence of outsiders pushing for greater leverage to juice returns. In addition, high insider ownership means the management team has a lot of its own skin in the game. As a result, as the company succeeds or fails, they personally succeed or fail.

Combine the two -- limited debt and high insider ownership -- and you have a recipe for a successful counterattack on Wall Street's pressure to "lever up."

Five companies set to dominate
Now that the damage has been done, the surviving companies have the opportunity to lick their wounds and recover -- and fill the gaps in the market left by their failed compatriots. And the companies in the best position to fill those gaps are those that survived strongest and most intact. You know, the ones with limited debt and significant insider ownership, like these:

Company

Total Debt
(in Millions)

Net Income
(in Millions)

Insider
Ownership

Market
Capitalization
(in Millions)

Morningstar (Nasdaq: MORN  )

$0

$87

57%

$2,481

National Instruments (Nasdaq: NATI  )

$0

$47

26%

$2,148

Intrepid Potash (NYSE: IPI  )

$0

$112

44%

$2,030

Quality Systems (Nasdaq: QSII  )

$0

$45

34%

$1,852

Lancaster Colony (Nasdaq: LANC  )

$0

$89

27%

$1,431

With a powerful combination like that, the sky's the limit as the economy turns around.

It's companies like these that form the core of our Motley Fool Stock Advisor service: nimble, financially strong, and run by leadership with their own skin in the game. If you're interested in owning your stake of companies like these before they take advantage of the white space opened up by the struggling giants, then join us today. If you'd like to see who has already made the cut as a Stock Advisor selection, click here to start your 30-day free trial. There's no obligation.

At the time of publication, Fool contributor Chuck Saletta owned shares of General Electric. Morningstar, National Instruments, and Quality Systems are Motley Fool Stock Advisor recommendations. The Fool owns shares of Morningstar and has a disclosure policy.


Read/Post Comments (11) | Recommend This Article (63)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 21, 2009, at 5:19 PM, blkbrd101 wrote:

    This article just confirms what I have always suspected - none of the experts know any more than I do.

  • Report this Comment On October 21, 2009, at 5:56 PM, dotphoto wrote:

    They look like fine companies, but the managements sell whenever they can. Ever since I bought your LOOP recommendation, I've stopped buying companies that have to compete on the upside with managements that are dumping shares. I'll take my chances with managements like CODI that are buying on the way up.

  • Report this Comment On October 21, 2009, at 6:48 PM, BRish wrote:

    This is terrific advice. The companies whose management is vested in the stock are the ones to buy.

    And Mysticstocks is right,... at the end of each Motley Fool article they tell you which stocks mentioned in the story are held by Fools; those would be the one to buy.

    That being said, MF usually offers terrific deals on their subscriptions and I learn alot from reading the reasoning behind the purchase.

  • Report this Comment On October 21, 2009, at 7:09 PM, TMFSelzhanik wrote:

    I like Best Buy, with the primary reason being that I've seen Circuit City, as well as many independant music / movie / home electronics stores, close their doors forever. With that one, I see "failed compatriots" all over the place.

    I want to like National Instruments, but who are their "failed compatriots"? What fallen companies did National Instruments previously compete against?

  • Report this Comment On October 21, 2009, at 11:58 PM, TMFBigFrog wrote:

    Hi Paul (TMSelzhanik),

    Perhaps that wasn't the clearest choice of wording on my part... The point I was trying to get across in that paragraph was the importance of a clean balance sheet in surviving the crash and preparing to take advantage of the opportunities that will present themselves as things recover.

    For many companies (such as the Best Buy / Circuit City example you brought up), many of the opportunities will come from space opened up from either failed or weakened direct competitors. For others, the opportunities will be from expansion into adjacencies or completely new business lines thanks to the removal of other companies in that industry. From what I can tell, National Instruments has more potential in the second camp than the first.

    -Chuck

  • Report this Comment On October 22, 2009, at 2:18 AM, vanyah wrote:

    I first became aware of National Instruments back in '99 when I was working at NASA.

    Their software product, Labview, is a great tool which allows Engineers to design software and hardware and test those designs without coding, allowing Engineers to get back to designing things without having to be Engineers/Programmers.

    The problem is this is an idea too far ahead of its time for industry to accept. Companies prefer to keep unit costs low and never seem to take into account the labor costs associated with repairing, maintaining, and replacing inferior technologies like the Microsoft operating system and the platforms it is installed on.

    In the absence of a “Paradigm Shift” in people’s approach to designing software and hardware you can expect sales of tools like Labview to remain as flat in the next ten to twenty years as they have been in the previous ten.

    Their chief competitor is a similar product known as Simulink, by the MathWorks, a privately owned company.

    I hope I’m wrong and Labview will become universally accepted, but I remain cynical about large corporations and government agencies and the accountants, lawyers, and “managers” they employ to make technical decisions.

  • Report this Comment On October 22, 2009, at 9:57 AM, Smittyh wrote:

    All 5 of these companies have very strong balance sheets and are very well run. MORN, NATI, and IPI also have very aggressive valuations with falling revenues. It appears that most of the upside is already in the stock price.

    QSII is shorted 19 days volume, revenue growth is 20%, earnings growth is -6%, and it pays a 1.9% dividend. 1 or 2 more good quarters and there may be a short squeeze that will make shareholders very happy. WATCH CLOSELY

    LANC has a PE of 15, 7% quarterly y/y revenue growth. On the surface, LANC seems to be the bargain, but much due diligence is required.

    FOOL ON

  • Report this Comment On October 23, 2009, at 10:57 AM, perrygriffin wrote:

    Doptphot hit the nail on the head. I think insider buying is the key to a stock that is headed up. I worked for JEC for twenty years and witnessed its rise in price from 20 to near 100 and the fat cats were dumping their stock options like crazy all the way up. In fact, I owned more stock than many of the officers. Look at it now---flatlined in the fifties. If a company's main purpose is to make a few undeserving cronies rich, stay away from it.

  • Report this Comment On October 23, 2009, at 7:05 PM, doncvr50 wrote:

    This sounds like Greek to me!

  • Report this Comment On October 23, 2009, at 8:57 PM, drborst wrote:

    I think vanyah is exactly right. (and I love these kids of posts, Thanks vanyah). And your post made me think of why I don't buy their stock today...

    When I was in grad school, the National Instruments guys came by with their pitch. I'd have bought it if they had some kind of University discount (and I probably would have bought the data aquisition boards they were selling too). But they wanted full price.

    Now that I've graduated and have a job, I run into things all the time that, upon reading your post, I think could be solved using Labview. But nobody I work with is familiar with it, and where I work, we hire programmers for that kind of stuf. If I and the guys I work with had gotton free stuf in school, I bet we'd all be clammoring for it. But we don't, and our programming staff isn't either (which means it isn't being given away at computer science schools either).

    So your right, flat sales from a company that could be the Apple of engineering computing.

  • Report this Comment On October 27, 2009, at 8:27 PM, Chinastocks55 wrote:

    GFRE: Gulf Resources.

    A top tier China energy stock.

    Opened on Nasdaq today.

    http://investorshub.advfn.com/boards/board.aspx?board_id=724...

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