One fun thing about the member profiles on our Fool discussion boards is that people can highlight a book they recently read and enjoyed. In my profile -- linked at the bottom of this article -- you'll find The Davis Dynasty, which was recommended to me by Fool co-founder Tom Gardner.
I recommend that book to all investors because it characterizes investing as a lifelong activity that makes up just a part of our lives -- a part that can have profound effects, both good and bad. The book covers the life of the Davis family from before the Great Depression all the way up to recent events.
Slow and steady wins the race
There are many tidbits of wit and wisdom that investors can take away from the book, but my personal favorite is "The Davis Double Play." To veteran value investors, the Davis Double will sound obvious. However, many folks might think the Davis Double is counterintuitive. The type of company that fits the bill is a consistent slow grower with growth rates of anywhere from 7% to 14% per year, instead of the high double-digit rates you expect out of companies such as Sirius Satellite Radio
The easiest double
Let's look at a hypothetical example: Nate'sWidgets (Ticker: NATE). Nate's Widgets isn't a glamorous company, but its widgets are used in many places, and because they are moving parts, they tend to wear out every few years and require replacement. It's a boring business, but it typically grows between 8% and 12% per year, and management does a good job of allocating capital. The general investing public doesn't pay a good deal of attention to Nate's Widgets, and every so often, the shares are trading at eight times earnings.
|
Nate's Widgets |
||
|---|---|---|
|
Year 1 |
Year 5* |
|
|
Price |
$8.00 |
$16.11 |
|
EPS |
1 |
1.46 |
|
P/E |
8 |
11 |
The benefits of buying a solid business at a relatively cheap price are evident in the above table. Because of Nate's consistent performance, the market gradually recognizes the performance of the business and rewards shareholders with a price-to-earnings ratio (P/E) that reflects Nate's steady growth. The process isn't exciting, but the results certainly are -- particularly if you have a long time to invest and can build a portion of your portfolio around such a strategy.
Often, a company like Nate's will earn an even higher P/E multiple because of the consistency of its growth, in which case an investor may get a double in three years instead of five. These businesses also tend to be reliable cash generators, which means investors can generally expect some form of a dividend that will give the total returns an extra boost.
Foolish final thoughts
This line of thinking resonates with me, because I've had some experience with it. I just hadn't put all the pieces together in my mind. I purchased shares of Outback Steakhouse
|
Company |
P/E |
Growth Rate |
|---|---|---|
|
Nutraceutical |
13 |
* |
|
Polaris |
14 |
14% |
|
CEC Entertainment |
16 |
12% |
It takes a bit of time and patience, but it's a sound strategy that can provide strong returns.
Philip Durell , analyst of Motley Fool Inside Value , scours the markets looking for doubles just like Nate's Widgets. In a little over a year, Philip has outperformed the market (as measured by the S&P 500) 10.7% to 8.1%. If you'd like to join the hunt for the market's hidden values, test-drive a 30-day trial to Inside Value for free. You'll get two stock picks per month, access to all the selections to date, and a Foolish community of like-minded investors in pursuit of a bargain. Click here to learn more.
This article was originally published on June 24, 2005. It has been updated.
Nathan Parmelee owns shares of Outback Steakhouse and beneficially owns shares of Nutraceutical. He has no financial interest in any of the other companies mentioned. CEC Entertainment is a Motley Fool Hidden Gems selection. The Motley Fool has adisclosure policy.
