“The greatest companies in lousy industries share certain characteristics. They are low-cost operators and penny-pinchers in the executive suite. They avoid going into debt. They reject the corporate caste system... Their workers are well paid and have a stake in the companies' future. They find niches, part of the market that bigger companies have overlooked. They grow fast - faster than many companies in fashionable fast-growth industries...
Pompous boardrooms, overblown executive salaries, demoralized rank & file, excessive indebtedness, and mediocre performance go hand in hand. This also works in reverse. Modest boardrooms, reasonable executive salaries, a motivated rank and file, and small debts equal superior performance most of the time.”
- Peter Lynch, "Beating the Street"
Peter Lynch is known for many of his ten-bagger picks, but a lesser-known fact is that his favorite industries are typically those with slow growth and boring operations.
In general, such industries attract few disruptors and little competition. The business operations or models do not need to change from one year to another. People seldom hear these company names on CNBC. Management has no fancy technology to showcase and few attractive stories to heighten investors' expectations. Any double-digit growth is the exception, not the rule.
These boring businesses focus on what they do the best in order to grow shareholder value day in and day out. Additionally, leaders in these industries usually enjoy fewer expenses and higher margins and may find themselves taking an increasing share of the market, as weaker competitors are likely to drop out.
As the growth potential is quite limited for some of these industries, companies largely depend on internal forces to drive the business forward, such as prudent capital allocation, responsible financing, disciplined spending, modest compensation, operational efficiency and decent corporate culture.
Although their stories often appear boring, great companies in "lousy" industries frequently generate higher risk-adjusted long-term equity returns than their counterparts in exciting industries.
Take a look at Rollins (ROL, Financial), for example, which provides pest control services and protection against termite damage, rodents and insects. The business appears dull at first glance, but it has been consistently increasing its sales and profits every year throughout the past two decades. We are not sure if such a stable track record is achievable by any high-tech star. As the market leader in a highly fragmented space minimally prone to technological disruption, Rollins enjoys numerous growth opportunities through market consolidation and regional expansion while delivering a handsome return on capital.
Similar to Rollins, Chemed (CHE, Financial) also benefits from little competition and relative stability in the two boring industries that it operates in – hospice and plumbing. Both are fragmented, offering consolidation opportunities, and slow-moving, attracting little attention and few competitors. Chemed dominates both industries in the U.S. with a near-monopoly position. Notably, Roto-Rooter, one of the company’s subsidiaries, serves approximately 90% of the U.S. population. You would probably never see any anti-trust investigation into this market-ruling plumbing and water cleanup business, nor would any capital-rich conglomerate find this space interesting enough to invest and compete.
As shown in the chart below, both companies steadily improved their returns on assets over the past 15 years.
Disclosure: The mention of any stock in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Rollins.
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