Motley Fool Hidden Gems Investing - Boring Companies, Exciting Returns

Episode Date: April 22, 2023

 “A company that does boring things is almost as good as a company that has a boring name, and both together is terrific.” --- Peter Lynch  Sierra Baldwin and Motley Fool Senior Analyst Sanmeet Deo discuss: - Boring, but effective ways to invest - ETFs that can build a portfolio - 1 key metric for investors to watch - The businesses of potato processing, car auctions, and paint manufacturing Companies and ETFs discussed: SPY, VTI, VT, CPRT, LW, SHW, PTON Host: Sierra Baldwin Guest: Sanmeet Deo Producer: Ricky Mulvey Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. People think in the investing and stock market is you always have to be doing something. You always have to be trading. You always have to be buying a new stock or selling a new stock or being very active in your portfolios. And really, a boring do-nothing strategy is probably one of the best. I'm Chris Hill, and that's Motley Fool's Senior Analyst, Sanmeet Deo. If you don't find investing very fun, that might actually be a good thing. Sierra Baldwin caught up with Deo to discuss how to make investing less exciting, some basic ETFs to consider, and some boring companies with market-beating returns.

A lot of people associate investing with the excitement of buying and selling stocks based on market trends and buzzy technologies that promise big returns. We saw a lot of that during the pandemic, but I'm wondering, should investing be fun and exciting? It was an interesting question because while the natural answer is yes, it should be fun and exciting. The real answer, if you want to make true long-term wealth in the stock market is it shouldn't be that fun and exciting. It's actually be very boring. You should almost not think about it too much. You should buy good companies for the longterm, the compound and not think about it too much. So fun, exciting comes when you go out into the out years, you made tons of money.

So fun, fun and exciting can work out thinking about companies like Netflix, Amazon, and Tesla. But when can that strategy really backfire? There are times when fun, exciting stocks or companies or story-type stocks are really exciting to invest in. But it has backfired. One of the very popular names during the pandemic was Peloton. And truthfully, lots of other connected fitness stocks. Companies that had fitness hardware combined with software that would be pushed out to their customers. Those didn't really work as well. Now, we're finding Peloton has struggled with their business. Some of the other themes, like 3D printing, was something that became very popular. It was really

fun and exciting back in the day. I don't think those stocks have really turned out very well. And then, the jury is still out on Metaverse stocks. Those were very hot and popular for a long time in the past couple of years ago. Haven't heard too much of them as AI has taken over the theme and the conversation there. So AI could be another one of those things that's fun and exciting. But is it a great strategy to invest in? We'll see. We'll talk about some good investing strategies later on. But before we get to some individual names, it seems like a lot of wealthy people have built a fortune in a pretty niche or dull way. One of the companies that we'll discuss a bit later on is Copart. Their founder, Willis Johnson, literally has a book called

From Junk to Gold because he became a billionaire salvaging vehicles. Another example that comes to mind for me is a McDonald's franchise owner in the town where I grew up was one of the wealthiest people. Can you think of any examples? Yeah, for sure. So when I was growing up in Houston, there was a family friend of ours that their family basically owned a business that made pipe and pipe products, iron products that they would sell to industrial companies. And that's it. Just fittings of small parts. And their business has thrived for 40 plus years. They're pretty wealthy and doing quite well just on piping products. What's one incredibly boring investing strategy that you use to build wealth long-term?

One of the things that people think in the investing and stock market is, you always have to be doing something. You always have to be trading. You always have to be buying a new stock or selling a new stock or being very active in your portfolios. And really, a boring, do-nothing strategy is probably one of the best. And one of the things that I found have been very helpful for me is an automated type of system. For example, I literally set aside, especially for my kids, since they have such a long timeframe now of investing ahead of them, I literally set aside automatically from my bank account into their financial accounts or brokerage accounts that I've set up for them. Every month comes out some money

that goes into their portfolios. I don't necessarily do something right away with that money, But when I feel the time is right lately, I've bought some index funds in, in, in, in their portfolios and that's it. I hopefully want to put money into their, into their accounts regularly on a monthly basis for a long period of time. And over time that, that will compound and build a nice nest egg for them to do whatever they want with it in terms of college or, or whatever else. So speaking of index funds, you know, you get a huge basket of stocks, and you don't have to do any of the picking, who should focus more on index funds than individual stocks? If you're not inclined to invest in stocks and spend a little bit of time

investing in stocks and businesses, learning a little bit about the businesses, it could vary on how much you want to do in terms of studying and due diligence on the businesses. But if you're going to own individual names, you should have a minimum level of knowledge of what you're owning what you're buying. If you don't want to do that, there's nothing wrong with that. A better bet is to just buy index funds. Honestly, I think index funds are a good staple of any portfolio to buy and anchor your portfolio. Then, if you want to add more names to your portfolio that are individual stocks, that add some spice to your portfolio, add some more flavor to your portfolio, that's definitely great. Some great index funds is the SPYDER S&P

500 ETF, SPY is the ticker. That's great for tracking the S&P 500, the 500 large companies in the United States. Vanguard Total Stock Market ETF, ticker VTI, covers the entire gamut of stocks, regardless of what index it is, in the United States. And if you want to get a little global exposure, you can go with the Vanguard Total World Stock ETF, which is ticker VT. That'll give you that total world global perspective on investing. I want to transition to some individual stock names. But before I do, we're going to be focusing on one metric, return on invested capital. Can you talk a little bit about what return on invested capital is and how you think it fits into the broader conversation about investing? Return on invested capital is one of the single

most important financial metrics for investors. So when a company has a high ROIC, it needs less capital growth earnings and therefore generates more free cash flow. A higher free cash flow leads to higher intrinsic value of the business that ultimately is reflected in the share price of the company. So higher RIC can lead to a higher stock price, which could lead to better returns for investors. Are there any times when investors should ignore the return on invested capital metric? So there's certain times when a return investment capital metric will not be as useful. A young company launching a new product or making an acquisition, it can get very wonky. You want to take an average or understand

whether the company is actually making profits to see if that return on investment capital metric will be useful. For steady, stable businesses generating healthy amounts of earnings and cash flow, it's definitely a great metric to use. And when it comes to picking stocks, another consideration is David Gardner's snap test. What would happen if you snapped your fingers and the company just completely disappeared? It seems like a lot of boring companies pass this test, even if you don't think about them very often. Yeah, for sure. The snap test is a great way, especially for boring companies. While these companies wouldn't be top of mind,

there are companies that are needed. For example, waste management services. If we snapped our fingers and had no more waste collection, we'd be in a lot of garbage, piled up on our streets, and be awful. If we had no funeral services companies to help us with those services that we need, regardless of economy or recession or anything happening, that would be very difficult for us. So there are plenty of companies that we don't think about that are actually very useful for our daily lives that if we were to snap and they were to go away, we would struggle through our daily lives. So getting into some examples of boring stocks and why you think they're worth considering. The first one is Lamb Weston.

This company doesn't seem to be disrupting the future of anything, but it definitely has a product that I'm grateful for. And it certainly doesn't pass my snap test. Um, can you talk a little bit more about what it does and how it makes money? Yeah. So, you know, one, one quote that I wanted to kind of mention too, is from Peter Lynch, where he said, you know, a company does boring things is almost as good as a company that has a boring name and both together is terrific. So land Weston, very boring name doesn't even imply what it actually does. You have no idea what it does just from hearing the name. But Lamb Wesson is the largest potato product manufacturer in the world, supplying giants like McDonald's with fries, yes, French fries,

while also selling its own consumer products. Over 60 million of their potato fries are sold daily. They even have an interesting tagline that says, seeing possibilities in potatoes. So, they basically make their money from taking potatoes, creating all kinds of products, whether it be fries, chips, any kind of potato product you can imagine, and selling those to restaurants, food companies. And usually, they have long-term contracts with those companies to sell their products. And they do quite well, given that simple, basic premise. And over the past seven years, the company has compounded revenues at 6%, EPS at 12%, and has an average ROIC of 23%. So, it's pretty impressive what they've done by just chopping up potatoes. It's definitely a company that I hope does not go away.

Next one, we talked a little bit earlier about Copart and how their founder, Willis Johnson, became a billionaire, literally turning junk into gold. what is the business and how is it doing today? Yeah. Copart is actually one of those names that was first recommended in Stock Advisor way back in August of 2007 and then Rule Breakers in April of 2009. Since the Rule Breaker wreck, it's returned over 1,952%. Again, Copart. Hear their name? Kind of boring. Don't know what they do. Copart is the largest marketplace and auctioneer of salvage and clean title vehicles. They serve insurance companies, banks, dealers, individuals, etc. It serves a different niche than typical used car sales, for example. Think of an insurance company selling off a totaled car or charities flipping car donations for cash. It sells about

3 million cars a year across 190 different countries. Over the past 10 years, the company has compounded revenues 13%, free cash flow of 50%, and has averaged an RIC of 32%. And also, one thing I want to mention about Copart is they have two parts of their business. The biggest part of their business is actually making money from selling cars and charging various service fees. And the majority of the revenue actually comes from these service fees. So, when someone sells a car through Carpart, they'll charge the seller a fee for their services, like organizing the auction, storing the vehicle, handling the paperwork. They also charge buyers fees, things like registering to bid, buying the car, and handling transfer of ownership.

So, all these different fees that they charge buyers and sellers kind of stack up into a significant source of income for them. And that's the majority part of their revenue. Another part of the revenue is where they just sell cars. So, they'll have salvaged or clean title cars that they get and they'll auction them off and sell them. And then they take a percentage of the sell price for themselves and give the rest to the seller. So that's a little bit of a smaller part of their business. Most of their business comes from the service fees and those really rack up given how their business has performed. Something very boring that probably no one you want to take on the task of doing. Yeah. When I think of a totaled car, I really

just think of an unsalvageable pile of steel and junk getting crushed in a junk lot and disappearing forever. So that's pretty impressive. How does their return on invested capital compare to the industry average and buzzier auto stocks like Tesla? Yeah. So there's a couple of companies that are publicly traded that do something similar to what they do. And those companies, Copart's returns have averaged, like I said, about 32% over the past 10 years. Some of these other companies, one is car auction services, and another is insurance auto auctions. It took a quick look, and they've definitely stacked up very well against those companies. Something like at Tesla, while Tesla in the short term does have a higher ROIC, the thing about Copar is they've

done 32% over the past 10 years. And if you look back even further, it's probably been similar or close and they've been around for a long time and done it consistently. And that's the other thing is companies that have a high ROIC, steadily rising and very consistent are definitely much more attractive. And if I were to an investor investing in Copart versus Tesla, I know that that Copart ROIC is probably going to stick around and be very similar to what it is now and what it's done historically versus a Tesla. I'm not really so sure how that ROIC is going to hold up, even though it is higher at the time. The last one that I want to talk about today is Sherwin-Williams. If you thought watching paint drying was fun, how about listening to it?

I will say that I just used Sherwin-Williams product to paint the exterior of my house, and I am a happy customer so far. But is this a company for investors to watch? Absolutely. Sherwin-Williams also was another one, first recommended stock advisor way back in March of 2008, ironically, in the same year as the housing crisis. And since then, it's returned 1,463%. For those that may not know, Sherwin-Williams is engaged in manufacturing, distributing, and selling of paint, coatings, and related products to not just retail customers, but professionals, industrial, and commercial customers in North and South America. Over the past 10 years, they've compounded revenues at 9%, EBIT, or operating

income at 11%. They've grown their dividends 17% and have averaged an ROIC of 28%. This is a company that is boring, sells paint. You think of paint drying, like you said. That's probably the best way to own a stock like this is let the paint dry and just watch it. They serve so many different people, so many different end markets that they've done very well. And if you think about it, it's also a brand name that is very... This kind of takes away... It's different from the other companies we've mentioned. It's not... Sherwin-Williams won't give you the idea of what they do. And it's kind of a boring name. But because they built a brand name, a lot of people will know what Sherwin-Williams is. They've seen the symbol

or they've seen commercials, things like that. So, this is definitely one that I would feel very comfortable knowing will always be needed, will stay tried and true, and will benefit from more houses, growth, and remodeling. With increased interest rates and a bit of a troubled housing market and some of the impact of that, slowing spend on remodeling, are those things that investors should be concerned about with Sherwin-Williams? I mean, definitely. It's definitely a risk for a company like this when there's macroeconomic uncertainty, housing slowdowns and slowdown in construction activity or slowdown in remodel spending. Definitely one of those things that will impact their company. It's not like

as if it won't. But let's take, for example, in the 2008 financial crisis, their net sales in 2009 dropped to $7.1 billion from $8 billion in 2008, representing a decrease of about 11.2%. Given the magnitude of that crisis, that's not too bad. And they've recovered ever since there. So while their business will surely take a hit, I'm fairly confident that they can recover through any sort of crisis. And they've been around for a very long time. So even during the 1980s recession when there was high interest rates, inflation, unemployment. They weathered that storm and are still going. So, they were founded in 1866. And so, they've seen plenty of different marketing conditions. No marketing condition in the future will resemble the same

market conditions that we've had. But they know how to handle those situations. Given that they have such strong returns on their invested capital, strong balance sheet, they'll be able to do fine. Well, thanks so much for joining me today, Sandmeet. I hope we didn't put our listeners to sleep. Thank you so much, Sarah. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.