Why Stamps.com Should Be on Your Watchlist

Stamps.com (STMP) a leading provider of Internet-based postage solutions, was recently featured on Forbes' "20 Non-Tech Stars Of The 2013 Best Small Companies List." Stamps.com has over 450,000 monthly subscribers -- primarily small businesses and enterprises -- who can purchase postage through an online or software interface. Subscribers of Stamps.com can simply print stamps from their home or office, paying up to 80% less on postage than what would be typically paid through standard avenues. 

The makings of a hidden gem
Stamps.com has a market cap of $618 million, with only three analysts following the company. Stamps.com's earnings are currently growing at 25% year over year, coming in at $34.58 million total over the past four quarters. Revenue has been growing at roughly 7.5% and is expected to increase closer to 9%-10% in the upcoming quarter and 2014.

Stamps.com has an impressive profit margin of 27.55% over the past four quarters, a number which is steadily increasing; the profit margin was 28.05% in the company's most recent quarter. The company raised its 2013 earnings guidance by 12% after reporting third quarter results in October.

Cash flow growth is equally impressive. In the three quarters so far reported in 2013, the company produced $33.2 million in operating cash flow -- already surpassing the $27.29 million of operating cash flow produced by the business in 2012. Over the past year, the company's cash position has nearly doubled to $73.54 million, with no debt on the balance sheet. Stamps seems to be a quickly growing cash machine. 

Stamps.com has an interesting management team heading up the company. Most of Stamps.com's executives (including CEO Kenneth McBride) have been with the company since 1999 (the company began operating in the mid-1990's). Even more interesting is that all of the company's executives are 45 years old or younger. In other words, Stamps.com's executive leadership has been with the company since they were 25 to 30 years old, working their way up the ranks of the company. 

Come on, do people even need postage anymore?
A valid concern is whether postage services will even be needed in an increasingly digital and prepaid-postage age. However, Stamps.com has seen notable growth in its cumulative base of monthly subscribers to 464,000 in the third quarter:

Stamps.com's base of monthly subscribers is increasing between 11% and 13% year-over-year each quarter. 

This growth likely stems in part from Stamps.com's innovative product offerings. For example, Stamps.com has a service specifically for independent sellers on the Amazon.com (AMZN -2.56%) Marketplace, in addition to a shipping software service for eBay sellers.

This is important to keep in mind, considering this January 9 announcement from Amazon (emphasis added):

Amazon today announced a record-setting year for Marketplace Sellers with businesses of all sizes selling on Amazon. In 2013, Marketplace Sellers on Amazon sold more than a billion units worldwide, cumulatively worth tens of billions of dollars. The Amazon Marketplace, which consists of more than 2 million Marketplace Sellers of all sizes worldwide, experienced record growth during the busy holiday selling season. On Cyber Monday, more than 13 million units were ordered worldwide from Marketplace Sellers on Amazon, growing the total units ordered by over 50 percent year-over-year. 

The dynamics of postage and shipping are certainly evolving, but Stamps.com appears to have a young and innovative team focused on leading the way in terms of postage and shipping software offerings. If anything, I expect Stamps.com to take the lead in the ongoing evolution of shipping and postal services in the U.S. Thus far, the Stamps.com's growing customer base confirms the company is indeed offering a valuable service. 

Concerns to consider 
Stamps.com has an abysmal 1.5/5 rating on Yelp. The company's customer count is steadily increasing despite these negative reviews, but there appears to be a disconnect between what people think the company offers, and the services that Stamps.com actually offers. In other words, only people who ship items semi-regularly -- not someone sending two or three letters each month -- will probably find it worthwhile to open an account with Stamps.com.

Another concern is that the company's hefty insider ownership of 14% is largely from independent directors of Stamps.com, rather than the team of young executives heading up the business on a daily basis. This concern of mine is offset somewhat by the fact that these executives have been with the company for 10-15 years. 

Foolish final thoughts
There is a lot to like with Stamps.com. It's led by a young and experienced management team, and offers an innovative product with a substantial (and growing) customer base. It also sports rock solid financials, with strong earnings and margins growth, increasing cash flow production, and a stellar balance sheet. 

The few analysts who follow Stamps.com expect the company to expand earnings at a pace of 20% annually over the next five years, a feasible number considering the company expanded earnings 37.2% annually over the past five years. Combine these expectations with the company's noteworthy performance thus far, and you have a quality small-cap business trading at a very reasonable P/E of 18 -- a hidden gem if I've ever seen one.