A Small Cap for the Long Run

About a year ago, I recommended United Fire & Casualty (NASDAQ:UFCS) to subscribers of my Motley Fool Hidden Gems service. The company possessed three of the core tenets we look for in our companies.

1. It was small.
2. It was undervalued by the market.
3. It was led by a dedicated CEO.

Celebrate small-cap value
United Fire & Casualty is currently capitalized at around $900 million -- setting it firmly in small-cap territory. It also sells insurance, a boring industry if ever there was one. And since the stock market is an enormous auction, speculators bid up shiny new tech companies -- not boring lots like United Fire. That can make for low valuations and fantastic profits for long-term investors.

Know your CEO
We also look for management teams that have long tenures and own a significant share of their businesses. In today's era, CEOs stay at the helm for fewer 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 20% for Hidden Gems. Since we're buy-and-hold investors, we're not even satisfied with that 20%. We believe McIntyre will reward us even more.

Foolish final thoughts
Founders and CEOs with large personal stakes in the success of their 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 founders or longtime CEOs and their companies:

While the 10-year returns of News Corp. have been disappointing, remember that this is an enormous, mature company. Its underperformance only highlights the importance of finding dedicated company leaders when their companies are still small.

That's exactly what we seek to do at Hidden Gems, and our portfolio of small caps is beating the market by more than 25 percentage points since July 2003. If you'd like to be my guest at the service free for a month and take a look at the companies we've already found, click here. You have my word that there is no obligation to subscribe.

For more on the power of small caps, check out:

• "A 25-Bagger in Five Years" by Tom Gardner
• "The Market's 10 Best Stocks" by Tim Hanson
• "70 Times Better Than the Next Microsoft" by Bill Barker

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.