One of the best things about investing in the kinds of small-cap companies featured every month in Motley Fool Hidden Gems is that they are so easy to understand. A $500 million operation such as Middleby (NASDAQ:MIDD), for example, has its fingers on many fewer ovens (to coin a phrase) than does a $340 billion monster such as General Electric (NYSE:GE). Unlike GE, which dabbles in everything from insurance to consumer financing to television programming to, oh yes, making electrical things, Middleby makes pizza ovens -- and that's about it.
Middleby's business was so easy to understand that when it was recommended, Hidden Gems subscribers could immediately see the company was undervalued. Those who bought in when the company was first picked in November 2003, and who are still holding for the long term, have already been treated to Hidden Gems' first three-bagger.
Today, I want to take a look at another company I like -- a mid cap this time, and much larger than Middleby (although nowhere near GE's size) -- that has a business model even simpler than the oven maker's. Natural gas pipeline company Kinder Morgan (NYSE:KMI) has four business segments, but the vast majority of its profits come from one activity: existing. More specifically, existing in the capacity of general partner to sister firm Kinder Morgan Energy Partners (NYSE:KMP) and collecting a hefty share of whatever profits KMP produces.
While the structure of these related firms is a little complicated, their business, as described above, is pretty easy to understand. The Kinder companies own pipes. Actually, quite a lot of pipes -- 35,000 miles of pipes. Other companies move natural gas and other hydrocarbons through those pipes. The Kinder companies collect a toll on whatever passes through their pipes. You can't get much simpler than that.
According to a press release issued yesterday, Kinder Morgan remains on track to hit its targeted $3.71 in per-share profits for 2004. Historically, the company's free cash flow is just a hair less than its GAAP earnings, so free cash flow in the neighborhood of $450 million looks just about right for the company this year. That would give Kinder Morgan a price-to-free cash flow ratio approximating its P/E ratio of 16 -- about 75% the valuation of the market at large. Meanwhile, the company pays a dividend yield that is twice the S&P average, and nearly twice what it was when I first wrote about this company back in December 2003. Those kinds of numbers make it easy for Hidden Gems investors and dividend-loving Motley Fool Income Investor subscribers, alike, to understand that Kinder Morgan has superior investment potential.
F ool contributor Rich Smith owns no shares in any of the companies mentioned in this article. The Fool has a disclosure policy .
