Boring Isn't Bad -- Ask Acme

 | Mar 07, 2014 | 10:00 AM EST  | Comments
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My Mad Money portfolio has a wide variety of companies, but none are more boring than Acme United (ACU). Even the name seems like something out of the Road Runner cartoons. Make no mistake, however: This supply company does two things that make it an invaluable part of my MM portfolio.

  • generates free cash flow
  • returns it to shareholders via dividends

That's really the key. Mad Money is full of energy names that are putting all their free cash "back into the ground" via aggressive, unconventional shale drilling. Also, many of these companies have raised capital -- usually via preferred stock offerings -- to augment spending from free cash flow.

So, to create a balanced portfolio, I needed to find a few names that are returning capital, and not raising it. That's where Acme United comes in.

Acme defines itself as "a leading worldwide supplier of Innovative branded cutting, measuring and safety products in the school, home, office, hardware & industrial markets." You can try and spin that into a "story," but you'll probably fail -- until you realize that Acme's dividend has more than tripled since 2005 to the currently indicated annual rate of $0.32 a share.

The great thing about companies that generate consistent free cash flow is that they are ridiculously easy to value. We stock geeks love our spreadsheets, and building a dividend discount model (DDM) on Acme is a straightforward proposition.

This is in contrast to tech/Web/social names, for which a DDM needs to assume a far-off date when the company's business prospects mature enough to pay a dividend, and then we discount back for 50 years to 100 years or whatever. It's a purely academic exercise, and basically a waste of time for the "go-go" tech names of this world. If you own Tesla (TSLA) or Facebook (FB) or Netflix (NFLX), the last thing in the world you would ever want the company to do is to begin paying a dividend. Look at Apple's (AAPL) performance relative to the Nasdaq 100 over the last two years if you need evidence of that.

But I try and try and try to explain to people that there are different modalities in the investing world, and success is not necessarily dependent on following the herd into a few popular names. Sometimes it feels like a losing battle, and in markets like that of the U.S. in 2014, deep value can be seen as out of favor. These times drive a value-hunter like myself into deep, deep, deep value.

This all explains my decision to use a 50% upside threshold for Mad Money. If I find a stock that I believe is undervalued by 10% to 15% there is a real risk that, even if the stock closes the gap, people may not notice. When market players come to expect higher rates of return, those of us who charge a fee to manage money need to pay attention -- and start generating alpha.

So for Acme, the most relevant DDM is the "H-method," which assumes a near-term period of growth and then a steady reversion to a long-term trendline. It's technical -- and subscribers to my newsletter, "The Portfolio Guru Post," will receive a full valuation analysis on Acme -- but to summarize: 

Using a capitalization rate of 7% and a near-term/long-term dividend growth rate for Acme of 10.5%/4.5% yields a fair value of: $22.18.

Yes, that's a cool 38% upside from current prices, and more than 50% upside from my Mad Money "in price" of $14.48.

So we own Acme, and I believe that the market will continue to realize the value in this name. The usual caveats would apply if we weren't in such a one-sided bull-bull-bull market. Acme is small, illiquid, underfollowed -- in short, everything I am looking for in a potential hidden-gem stock in markets where values are few and far between.

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