A Small Cap for the Long Run

A few months back, I recommended United Fire & Casualty to subscribers of my Motley Fool Hidden Gems service. United Fire & Casualty possesses some of master investor Peter Lynch's core investment characteristics. Who's Peter Lynch? He was the manager of Fidelity Magellan, a fund that under his stewardship returned 29% per year for 13 years -- turning a $10,000 investment into a nearly $300,000 fortune.

Celebrate boring businesses
One of the traits Lynch looked for in companies -- and something we look for at Hidden Gems -- is that they are in a line of work that is boring or distasteful. You see, the stock market is an enormous auction, and speculators bid up shiny new tech companies -- not those that build funeral homes or handle environmental waste. That makes for low valuations on boring lots, and fantastic profits for long-term investors. United Fire & Casualty sells insurance, and folks generally don't get too fired up about owning insurers.

Know your CEO
We also look for management teams that have been in the game since the beginning. In today's era, CEOs stay at the helm less than five years (on average), sell options at the end of every year, and hightail it to Bora Bora when their tenure is up. They live happily ever after without ever 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 very long periods of time. These superior leadership teams recognize that the biggest gains in the market are made over decades because of the power of compounding.

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

United Fire & Casualty 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 it's up more than 40% for Hidden Gems in the past eight months. Since we're buy-and-hold investors, we're not even satisfied with that 40%. We believe McIntyre will reward us even more.

Foolish final thoughts
Boring businesses can lead to long-term outperformance for opportunistic investors. Johnson Controls, anyone? The facility-controls company is up nearly 20 times since 1991. If I can find a boring business with dedicated and tenured management, my interest is piqued.

Founders and CEOs with large personal stakes in the success of their company have spurred many of the market's biggest success stories. As my cousin said recently -- he and my uncle manage a few billion dollars out of their value firm in Pennsylvania and have outstanding 25-year returns -- "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 their companies:

These are exactly the sorts of businesses and companies we look for at Hidden Gems (yes, we'll occasionally look at a hotshot tech company like Oracle, as long as it has smart management), and we're confident that we can find a lot of them -- thus far, our small-cap picks are up an average of 29% and our portfolio is beating the market by nearly 20 percentage points. While we can't expect to sustain 29% average returns, even 18% returns would turn a $10,000-per-year program of savings and investment into $1 million in approximately 15 years. If you'd like to take a free one-month trial to look at the nearly 50 companies we've already found and interact with investors who are actively following these companies, click here. You have 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. Mercury General is a Motley Fool Income Investor recommendation. The Fool has adisclosure policy.