We're all familiar with the great growth stocks of history -- the ones that would've made you rich if you'd just bought and held at the right time. But what about lesser-known stocks that achieved equally great growth?
Contrary to popular belief, not all of tomorrow's great companies have already been discovered. Looking where others aren't can reveal extraordinary growth opportunities that don't make the headlines. Illinois Tool Works
Hiding in the wings
Illinois Tool Works isn't a household name, but it certainly is a household presence. The company turns out all kinds of fasteners, metal and plastic pieces, tools, and a whole range of things that might best be classified as "doodads." They're used in cars and houses, or on the assembly lines that make other products we all use.
How can a company become immensely successful making what seems like a random agglomeration of doohickeys (albeit with some very expensive, complex doohickeys in the mix)? As it turns out, that's not quite what ITW does. In fact, it stopped manufacturing anything a long time ago.
Instead, ITW now makes money by managing the smaller companies it buys and streamlines. While many studies show that companies that grow by acquisition generally do poorly by their shareholders, ITW seems to be the exception to the rule, like Warren Buffett's Berkshire Hathaway
Looking inside ITW's toolbox
Illinois Tool Works has been able to grow successfully by acquisition because it's developed a standard methodology over the years for making acquired companies more profitable. It's based on the standard "80/20" rule, which says that 80% of a company's success comes from the most productive 20% of its efforts. This isn't exact, but it's a good approximation in many cases.
In evaluating a potential acquisition, ITW's management asks several key questions. Are a small number of the company's customers responsible for most of its sales? If so, can we restructure the company to meet those customers' needs more efficiently? Do a handful of products generate the majority of profits? If so, can we pare back or eliminate their less profitable counterparts? If managers get good answers, they go forward with the acquisition.
Running the numbers
With more than 700 separate business units under its roof, Illinois Tool Works has gotten pretty good at integrating new acquisitions. Returns on equity have jumped to 20% in recent years, while the company's debt-to-equity ratio has remained below 0.2. That means the company is producing those returns without taking on extreme leverage.
More importantly, I'm confident that the company has aligned the interests of management with those of shareholders, mainly thanks to the number of shares managers hold. But the company's compensation structure is complex, employing both share grants and option grants. I prefer companies that award only share grants, such as TCF Bank
ITW's director compensation is also fairly complex, and yearly director cash compensation has just been bumped from $40,000 to $135,000. That's close to executive compensation for some smaller companies. If ITW feels the need to increase board compensation, it could at least use restricted stock grants, rather than cash. Fools should keep a close eye on this area in the future.
To buy or not to buy?
Thanks to current concerns about ITW's performance during a potential economic downturn, you can pick up its shares at a somewhat lower P/E ratio than normal -- but not much lower. This stock has given investors few obvious buying opportunities.
As much as I like Illinois Tool Works, I'm in no hurry to buy it. Its earnings have historically been hurt during recessions, and the 50% of its earnings derived from foreign markets -- primarily Europe, but with a presence in Asia as well -- won't protect ITW in the likelihood that the global economy takes a breather.
Meanwhile, other relatively unknown companies might be a better fit for your investing money. When markets are shaky, it's tempting to stick with proven, well-known growth companies like General Electric
As for Illinois Tool Works, I'll probably wait and watch the stock for a while. At some point after a small dip, I may nibble a bit. That will keep me interested enough to follow the stock for the long run, in hopes that a rare buying opportunity emerges.
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Fool contributor Kenneth McDonald welcomes your feedback. He currently holds no shares in Illinois Tool Works or any of the other companies mentioned in this article. Dell and Berkshire Hathaway are both Inside Value and Stock Advisor picks. The Motley Fool owns shares of Berkshire Hathaway. The Fool has a disclosure policy.