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Someone recently gave me an analyst report on
. The report was superb, laying out the rationale to be long-term bullish on a company that has changed the face of home-improvement retail.
What's interesting is that this strong buy recommendation was written by an Alex Brown analyst way back in 1991. Since then, Home Depot has grown sevenfold, from a $10 billion company to a $70 billion company.
Building for the Long Term
Buying companies like Home Depot early in their growth cycle is rife with advantages for the investor. Forget worrying about the daily quote. If your plan is to hold as long as the story is intact, the short-term quote becomes meaningless.
Whether we're in a bull or bear market in equities also becomes meaningless. You aren't going to enjoy a sevenfold increase in a stock if you attempt to trade around bull and bear market cycles. Worrying about the health of the economy, the level of interest rates and the price of oil are irrelevant if you own a Home Depot-type story early in its life cycle.
And taxes? Uncle Sam can wait. In the case of investors who bought and are still holding Home Depot based on the Alex Brown recommendation back in 1991, they haven't paid a dime in capital gains taxes. All of their original capital plus their unrealized gain is still working for them.
Are there some Home Depot-type stocks available in the marketplace today? You bet. Here are a couple of companies that I think have an excellent chance of bringing home multifold capital appreciation over the next decade or so.
First, though, here's the common thread that weaves through these business models: First, each model brings positive structural change to the playing field in which they operate. And second, each company is relatively small and has enormous expansion potential.
You can't find a company with an impressive long-term record of growth that sports a price-to-earnings ratio below 25. They don't exist. That is, with the exception of
, a company with a 10-year track record of over 25% annual growth. It sells for the absurd valuation of 13 times next year's earnings.
Here's the kicker: All of the growth at Commerce is organic. There are scores of companies that grow by acquisition. It's a high-risk avenue of growth. Mistakes are made all too often. But the list of companies that have generated impressive organic-only growth is quite short --
Bed Bath & Beyond
Commerce's story is just getting started. It will be expanding into the greater Washington D.C. area, Boston and then Florida over the next several years. The bank has already harvested large chunks of market share by offering a vastly better product in New Jersey, Philadelphia and New York City.
Buying a used car from a dealer is considered by many to be about as enjoyable as going to the dentist.
is changing the used-car buying experience on a number of levels. For example, it offers strict, no-haggle prices. Its network of stores is grabbing market share in the heavily fragmented, inefficient used-car marketplace.
I've seen several analyst reports that lavish praise on the business model of CarMax, a company growing organically at a 25%-30% clip. Many of these analysts stop there, though, and don't rate CarMax a buy because it sports a P/E multiple of 26.
I think that's a big mistake. Parse the long-term story at Home Depot and you'll readily see not one, but two levers that created the sevenfold (since 1991) increase in market value. Sales growth is the obvious lever. Margin leverage is the less-obvious lever.
Without exception, every great retailer realizes economies of scale resulting in higher profitability as their story matures: The net profitability of Home Depot increased by 50% from 1991 to today, with net margins growing from 4% to 6%. Selling a commodity product,
increased its net profitability from 2% to over 6% over a period of years.
By my estimation, CarMax should be able to secure at least 4% net margins as the story matures, up from the current 2%. If I'm right, buyers of CarMax stock at the current quote are paying 13 times normalized earnings at the current quote. That's a cheap price to pay for a retailer that is growing organically at over 25% per year, with huge potential for expansion for years to come.
At time of publication, Alsin and/or ACM was long Commerce Bank and CarMax, although holdings can change at any time.
Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to