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 their line of work is boring or distasteful. You see, the stock market is an enormous auction, and speculators bid up shiny new tech companies -- not companies 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 long tenures and own a significant share of their business. 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. 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 nearly 30% for Hidden Gems in the past nine months. Since we're buy-and-hold investors, we're not even satisfied with that 30%. We believe McIntyre will reward us even more.

Foolish final thoughts
Founders and CEOs with large personal stakes in the success of their boring businesses have spurred many of the market's biggest success stories. And 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 CEOs with more than 10 years experience at their less-than-"hot" companies:

Airgas distributes nitrogen, oxygen, helium, argon, and dry ice (among other snooze-inducing products). Its CEO, Peter McCausland, has been in charge since 1987. During that time, the stock has been a 30-bagger. These are exactly the sorts of profitable, under-the-radar businesses we look for at Hidden Gems, and we're confident that we can find a lot of them.

To date, our small-cap picks are up an average of 34%, and our portfolio is beating the market by more than 20 percentage points. While we can't expect to sustain 34% average returns, even 17% returns (half our current level) would turn a $10,000-per-year program of savings and investment into $1 million in approximately 18 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. Or you can subscribe and get a free copy of The Motley Fool's Stocks 2006: The Investor's Guide to the Year Ahead.

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.