Companies in the retail sector are highly exposed to cyclical economic conditions as well as high competition. Neither of these are qualities a long-term investor typically looks for.
Companies such as Abercrombie & Fitch (NYSE:ANF) and Dick's Sporting Goods (NYSE:DKS) saw their earnings decrease drastically during the latest economic downturn in 2008 and 2009. High competition can also lead to pricing pressures, pushing down margins, Abercrombie and Dick's had net profit margins of just over 1% and a bit over 5% last fiscal year, respectively.
Now what if I told you about a retail company that sells products you could find at Abercrombie or Dick's, but is not exposed to margin pressures and has the potential to actually increase sales during downturns in the economy?
This is where Winmark Corporation (NASDAQ:WINA) comes into the mix. Winmark is a small and not very well known company, however those who knew of them and invested in them five years ago have made out very well.
Though you may have never heard of Winmark, you have most likely heard of or shopped at stores it franchises. The company's market cap of under a half billion dollars is deceptively small once you notice its large reach. The company uses an all-franchise model with more than 1,000 stores across the U.S. and Canada under the brands Plato's Closet, Once Upon A Child, Play It Again Sports, Music Go Round, and Style Encore. All five of these stores specialize in selling high-quality, gently used, or occasionally new products.
These stores represent quality and affordability, stores where you can buy nearly new brand-name goods at very steep discounts. Hard economic times tighten the budgets of many families, yet kids continue to outgrow clothes, try new sports, and want to learn new instruments no matter what economic times we are in. This is where Winmark's brands shine in investors' eyes. I would never go as far as to say that any retail stores are recession-proof. However, all five of Winmark's brands make a case for being recession-resistant.
The average middle class person would gladly buy a gently used version of Abercrombie's new style from Plato's Closet or a gently used hockey stick from Play It Again Sports at a very steep discount, especially during hard times. This is what makes Winmark so attractive to long-term investors.
Now that we know about their stores, let's go on to how Winmark actually operates, and why it is such a good model.
Winmark is in the business of franchising their store brands. This means that they do not own the stores in these names, instead they let individual business owners own and manage the stores, and in return Winmark receives a royalty fee based on a percentage of sales. This is a great business model for investors because they will get to participate with the top-line growth of the stores, yet they are not necess arily participating in the downfalls of pressured margins or store-level operational inefficiencies.
The quantitative side of things
Over the last 10 years, Winmark has grown revenue from $27 million to $56 million, or a little over 7.5% a year on average. Also notable is that the company boosted its top line all the way through the deep recession of 2007 to 2009. Over the same 10-year time horizon, Winmark's net income and earnings per share have risen at an average pace of over 16% and 18% per year, respectively.
Growth is one thing, but it is also nice to see a company with efficient operations, and Winmark again passes the test. Its average profit margin over the last 10 years stands at more than 17%, with it being at or above the 25% range over the last four years as well. Your eyes may be wide if you remember the 1% and 5% profit margins from Abercrombie and Dick's which were earlier stated.
Along with growth and efficiency, what else does Winmark offer investors? How about very strong balance sheet? Winmark has only $15 million worth of total liabilities and nearly double that in cash, with $29 million as of the end of 2013.
It is very rare to find a company that has spectacular growth in earnings, high margins, and a squeaky-clean balance sheet trading at 22 times earnings with the broad market trading at 18 times earnings. Abercrombie and Dicks are selling at 53 and 20 times earnings, respectively. I believe Winmark's premium valuation in comparison to the market is well deserved due to their strengths.
Also worth mentioning, this company is held very tightly, with insiders -- board members and executives -- owning more than 45% of the outstanding shares. There is no better way to be sure of managements' shared interest with investors than management having skin in the game, and Winmark's has quite a bit of skin in the game.
I believe Winmark employs an excellent business model, as franchising takes a lot of risk out of the equation from a store-level operational standpoint and lets the company grow with their brands. Though you may have never heard of Winmark before today, this is an excellent company you should have your eyes on in the future.
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Jacob Meredith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.