The classic business book The Millionaire Next Door, by Thomas Stanley and William Danko, depicted a quiet lot of wealthy entrepreneurs who made their fortunes in unglamorous, under-the-radar enterprises such as paving contracting, scrap-metal processing, plumbing or industrial supplies. These individuals clearly know how to spot a basic, consistent need and profit handsomely from it.
Quite often, however, investors can be star-struck by what I like to call "drama stocks" -- stocks that live or die by a sexy idea. Apple Inc. (NASDAQ: AAPL), Chipotle Mexican Grill (NYSE: CMG), or online travel hub Priceline (NASDAQ: PCLN) are examples of such stocks (although I'm not really sure what's so sexy about burritos wrapped in tin foil). Investors have a tendency to bid these stocks up to ridiculous, triple-digit levels and punish them on the slightest hint of bad news. This was the case with Chipotle recently, when it announced second-quarter revenue of $691 million a little shy of the projected forecast of $705 million. The shares dropped 21% on the news.
But as The Millionaire Next Door tells us, the bland and boring stocks can be extremely beautiful and profitable, not to mention they are safer than "drama stocks."
And that's precisely why garbage hauler Waste Management (NYSE: WM) has caught my eye lately.
From trash to treasure...
With a consolidated market cap of $16.2 billion, Houston-based Waste Management is the nation's largest trash hauling/disposal company, serving nearly 20 million customers. About 55% of last year's revenue of $13.3 billion came from collection, 17% from landfill management, 10% from waste-to-energy operations (which are poised to grow exponentially), 10.3% from recycling and the remaining 10% from other operations.
Guided by a focused management team, the company possesses a solid balance sheet, which are key criteria when considering buying a company's stock.
Things are looking good for Waste Management. In the first-quarter of 2012, volume grew organically for the first time since 2006 and the company has issued earnings-per-share (EPS) guidance of $2.22 to $2.30 for the year. If is the company is able to achieve the upper end of this guidance, then this would represent EPS growth of more than 12% compared with last year's $2.04: no small feat in a tough business climate in a sector where growth can creep in inches.
But the real positive about Waste Management is its ability to generate free cash flow. This year, the company projects free cash flow to come in between $1.1 and $1.2 billion. Management has pledged to use the cash on three fronts: 1) stock buybacks 2) acquisitions and 3) dividend increases.
This kind of shareholder-friendly behavior is exactly what you should be looking for in a stock. In fact, they're the kind of moves that would put the company among what StreetAuthority co-Founder Paul Tracy calls "The World's Greatest Businesses."
Last year, Waste Management bought back $575 million worth of its common shares and plans to buy back another $500 million in 2012. The company's acquisition strategy will also likely add to the bottom line. Last year, the firm bought Oakleaf Global Holdings for $425 million. Oakleaf came with a network of 2,500 haulers and most important, $580 million in annual revenue. The significance is that Waste Management only paid 73 cents on the dollar for one year's sales, something I consider a steal. As long as management can buy low, things should work out well.
In addition, with an already-generous dividend yielding around 4%, management has voiced commitment to grow that as well.
The bull case for industrial stocks...
While cyclical in nature, it always makes sense to hold industrials like Waste Management in your portfolio. It's safe to argue that we're more likely to be in a downswing rather than an upswing as far as the performance of industrial stocks is concerned. But this just means now is the ideal time to begin building positions.
Some investors might think they're being smart by scooping up shares of triple-digit behemoths like Apple when it pulls back from the $620s to the $610s a share, but don't be fooled. The truly intelligent investor, to co-opt the title of Ben Graham's famous work, will buy high-quality stocks cheap when the sector is out of favor. (It's also what Paul Tracy tells readers of his Top-10 Stocks newsletter to do in order to find a "Forever Stock" that you can buy, hold and profit from for a lifetime.)
The U.S. economy is, at best, muddling through the post-financial crisis world while the rest of the world seems to be slowing down which, in turn, makes for nervous markets and sectors, especially those that seem more economically sensitive than others.
Obviously, waste disposal can be viewed as economically cyclical (the theory is that the stronger economy generates more trash which, to some extent is true). But I would argue that while volumes may rise and fall, garbage has to be removed no matter how the economy is doing. Therefore, Waste Management is more defensive than it appears at first glance.
Risks to Consider: Rising fuel costs have a significant effect on Waste Management's margins and, of late, that's a genuine concern. But the company has earmarked a significant portion of its projected capital expenditure budget ($1.4 to $1.5 billion for 2012) toward adding natural gas vehicles to its fleet. Also, while softer sales volumes could be expected due to a challenging economy, the company has initiated a series of internal cost controls that include reducing headcount and improving general administrative expenses from 11.6% of revenue to a target of 9%: a 22% improvement.
Action to Take -->Waste Management shares currently trade at around $35 with a forward price-to-earnings (P/E) ratio of 16 and a dividend yield of around 4%. Key catalysts of a $43 price target in the next 12 months include a projected 5% EPS growth, margin expansion achieved through internal restructuring and good management stewardship, and the fact that many yield-hungry investors are underweighted in the industrial sector.
-- Adam Fischbaum
P.S. -- Why are stocks like Waste Management making some investors wealthier year-in and year-out, despite one of the most turbulent periods in stock market history? StreetAuthority co-Founder Paul Tracy has put together a special report called "The World's 12 Greatest Businesses," in which he shares his findings, including the names and ticker symbols of what he believes are the best businesses to own shares of right now. Go here to learn more.
Adam Fischbaum does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.
This article originally appeared on StreetAuthority
Author: Adam Fischbaum