Fabrice Taylor, CFA, publishes the President’s Club investment letter. His letter and The Globe and Mail have a distribution agreement.
Contrary to what we’re led to believe, the stock market is generally not home to the best and brightest businesses. It’s home to companies that need outside capital or to spread out the risks of their business.
The best firms generate enough profits to fund their growth without the need to bring in capital from outside investors. That’s not to say that listed companies aren’t good investments – rather that the best stocks are those of companies that resemble private firms as much as possible.
Here are the hallmarks:
-Typically, insiders will own a lot of the stock, and will not be sellers.
-They will have a long history and generate high returns on equity, which means they rarely need to raise share capital.
-They will tend to deploy their capital carefully, reinvesting profits to expand when it makes sense, paying out dividends or buying back shares when there are no good investments to make.
-Perhaps most important, they won’t be well covered (or covered at all) by “sell-side” analyst research, meaning they’re likely to be cheap, since stocks that aren’t recommended tend to be less sought after.
Accord Financial is one such firm, and I think the stock is worth buying. I bought it very recently. It fits this investment thesis very well.
You’ve probably never heard of it, but Accord was founded about 35 years ago by Ken Hitzig, now chairman, with backing from Austin Beutel, the financier who also helped found investment powerhouse Beutel Goodman.
Accord is a niche lender to smaller companies who need to finance inventory and accounts receivable. It has paid a regular dividend for more than 20 years and has increased that dividend pretty much every year. The current yield is an attractive 4 per cent.
Insiders and people close to them, including Mr. Hitzig and Mr. Beutel, own about 60 per cent of the shares and have not been sellers recently.
Accord lends its customers money to finance inventory or receivables. The lender aims to maximize the spread it earns. Mr. Hitzig also likes to be first in line for security on assets, hence the collateral for loans consists mainly of receivables, inventory and, to some extent, hard assets. He also watches that collateral actively to reduce risk.
In the first nine months of 2013, Accord earned 47 cents a share. The fourth quarter is seasonally the strongest, and I figure the company will end the year at somewhere between 80 and 85 cents a share of earnings.
That translates into a return on equity of almost 15 per cent, which is more impressive when you consider that the company is conservative when it comes to debt. In good years, I reckon it can do even better.
Besides paying increasing dividends, Accord has also bought back a lot of shares – a total of about $15-million worth over the past decade.
Combined with regular and special dividends, the company has given almost $50-million back to its shareholders in the past 10 years. That’s more than two-thirds of the current market cap returned to shareholders in a decade, which is very impressive.
It’s worth noting that the company tends to keep profits when it has something promising to invest in and to pay them out as dividends when it doesn’t.
Accord remained profitable and kept paying dividends during the financial crisis and also bought back shares. It didn’t buy back shares last year, which tells me business is picking up and management sees opportunities, which isn’t surprising given the improving U.S. economy, where Accord produces half of its earnings.
So, investors buying this stock now are getting my two favourite things: growth and value.
I figure Accord can earn $1 a share this year, meaning the stock is quoted at nine times earnings. Given what I expect to be an above-average growth rate, top-drawer management, dividend history and the potential for a takeover bid, I believe the stock should trade at 12 times earnings.
What’s more, I think the price-earnings ratio will move higher as the company posts above-average earnings growth. That suggests a stock price of $12, which, along with the dividend, offers a very nice return of almost 40 per cent from current levels.
As an added bonus, the company is open to acquisitions, which can drive earnings higher faster. It bought a loan portfolio late last year that I figure can add a dime a share of earnings. More tuck-in acquisitions are possible.
So, to summarize, the stock is cheap, investors have exposure to capital gains and income, and they can sleep at night knowing the book value is about $6.50, so the downside is very limited.
We’re in a frothy market and, in my view, investors should dial back their risk tolerance. Stocks like Accord are go-to investments in this environment.