A Small Cap for the Long Run

About a year ago, I recommended United Fire & Casualty to subscribers of my Motley Fool Hidden Gems service. Why? Because the company possessed three of the core tenets we look for in our recommendations.

  1. It was small.
  2. It was undervalued by the market.
  3. It was led by a dedicated CEO.

Celebrate small-cap value
United Fire is currently capitalized at about $800 million -- setting it firmly in small-cap territory. It also sells insurance, a boring industry if ever there was one. And since the stock market is an enormous auction, speculators bid up shiny new tech companies -- not boring lots like United Fire. That can make for low valuations and fantastic profits for long-term investors.

Know your CEO
We also look for management teams that have long tenures and own a significant share of their businesses. In today's era, CEOs stay at the helm for fewer than five years (on average), sell options at the end of every year, and hightail it to Bora Bora. They live happily ever after without creating lasting value in the business that made them rich. Therefore, I scour the market for managers who put their reputations and compensation packages on the line for long periods of time. These superior leadership teams recognize that the biggest gains in the market are made over decades -- not days -- because of the power of compounding.

When we find these factors in tandem at Hidden Gems, we sit up and take notice.

United Fire was founded in 1938 by Scott McIntyre. He turned the company over to his son, who continues to own a substantial stake in the business he's been with since 1958. The company's stock is up 160 times since 1972, and I believe McIntyre will reward us even more if we stay with him.

Foolish final thoughts
Founders and CEOs with large personal stakes in the health of their businesses have spurred many of the market's biggest success stories. My cousin -- along with my uncle, who together manage a few billion dollars out of a value firm in Pennsylvania and have had outstanding 25-year returns to boot -- said recently, "We have come to the realization over time that insider ownership is one of the most important indicators, maybe the most important, of sustained success in the public markets."

For proof, just take a look at these founders and/or longtime CEOs and their companies:

Company

Founder/CEO

CAGR* since one year after IPO

Pixar (Nasdaq: PIXR  )

Steve Jobs

24%

Amazon.com (Nasdaq: AMZN  )

Jeff Bezos

22%

Papa John's (Nasdaq: PZZA  )

John Schnatter

14%

Netflix (Nasdaq: NFLX  )

Reed Hastings

31%

TD AmeriTrade (Nasdaq: AMTD  )

Joe Ricketts

37%

Toll Brothers (NYSE: TOL  )

Bob and Bruce Toll

21%

Apollo Group (Nasdaq: APOL  )

John Sperling

27%

Average CAGR

25%

*Compound annual growth rate. Data supplied by Capital IQ.

This chart highlights the enormous return potential of finding dedicated leaders when the companies are still small. After all, 25% annualized returns will turn $1,000 into nearly $10,000 in 10 short years.

Outsized returns are exactly what we seek to achieve at Hidden Gems, and our portfolio of small caps is beating the market by nearly 25 percentage points since July 2003. If you'd like to be my guest at the service free for a month and take a look at the companies we've already found, click here. There is no obligation to subscribe.

This article was originally published on Aug. 11, 2005. It has been updated.

Tom Gardner, co-founder of The Motley Fool, is the lead analyst of Motley Fool Hidden Gems. Tom does not own shares of any company mentioned in this article. The Fool has a disclosure policy.


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