Someone who reads my articles sent me this email:
I recently read the book "Hidden Champions of the 21st Century" by Hermann Simon and I would like to attempt to uncover some of these types of highly entrenched, highly focused, “super-moat” companies. I think this ties in with your “watchlist” approach, and is something you touched on in your Invest with Style piece if I’m not mistaken.
"Hidden Champions" is one of my favorite books. If I could recommend only one book for value investors to read it would be "Hidden Champions." I know people will read Ben Graham, Joel Greenblatt, etc. Most people won’t read "Hidden Champions." And that’s a shame. Because it teaches you a lot of things that you can apply to your investing right away.
The way to know if you have a hidden champion or not is to analyze the business. Not just the past financial record. But there are thousands and thousands of stocks out there – especially in the under $100 million and under $1 billion market cap categories.
Most stocks have a market under $1 billion. There’s a simple reason for that. Most companies will never grow to be $1 billion companies. Reading about Exxon Mobil (XOM) and Apple (AAPL) and Starbucks (SBUX) and thinking you are becoming a business expert is like reading about blue whales and elephants and thinking you are becoming an animal expert. Tiny insects are a lot more common than giant mammals. Hidden champions are a lot more common than global Goliaths. Companies like Apple and Starbucks and Exxon Mobil can only grow up in very special environments.
So, the good news about hidden champions is that they are worth studying. The bad news is that unlike Exxon Mobil, Apple, etc., they do not stand out. You have to find them from among thousands of companies of similar size.
This sounds like a job for a screen.
The results you get from any screen are just a starting point. I am not saying these companies are hidden champions. I’m saying that if you only have a couple hours to devote to company research each week – you can start with this list instead of going through all public companies from A to Z.
As far as specific screens that might help uncover Hidden Champions, here are a few ideas:
1. Companies with 10 years of consistent 15% or higher operating margins and a market cap less
than $1 billion
2. Companies with 10 years of consistent 15% or higher return on equity and a market cap less than $1 billion
3. Companies with 10 years of consistent 8% or higher return on assets and a market cap less than $1 billion
4. Companies with 10 years of consistent earnings per share increases and a market cap less than $1 billion
Number 2 and 3 are really one screen. You need to include an ROA exemption to allow companies with no leverage to be put on equal footing with companies that use leverage. After all, you asked about Hidden Champions – not companies that were necessarily maximizing their return on equity through their financial decisions. Generally, an unleveraged company (outside of financials, utilities, transports, and a few select industries) that earns an ROA equal to half the ROE of a “normally” leveraged competitor has operations that are about equally profitable. In other words, if an ultra-conservatively managed family company earns 10% on equity it would probably earn closer to 20% on equity if it was sold to a professionally managed multinational.
Of companies with an operating margin of 15% or more in each of the last 10 years, only one Noble Roman’s (NROM) is under $100 million market cap. But between $100 million and $1 billion million there are:
· Utah Medical Products (UTMD, Financial)
· Young Innovations (YDNT, Financial)
· National Research Corporation (NRCI, Financial)
· U.S. Ecology (ECOL, Financial)
· Landauer (LDR, Financial)
· Meridian Bioscience (VIVO, Financial)
· Amsurg (AMSG, Financial)
· Mobile Mini (MINI, Financial)
Very few companies consistently post an operating margin greater than 15%. This equates to about a 10% after-tax net margin in the U.S.
A consistent 15% ROE record is easier for companies to pass. Under $100 million in market cap we have:
· Advant-E (ADVC, Financial)
· Psychemedics (PMD)
· Rocky Mountain Chocolate (RMCF)
· United-Guardian (UG)
· Cherokee (CHKE)
Between $100 million and $1 billion we have:
· VSE (VSEC)
· Omega Flex (OFLX)
· PetMed Express (PETS)
· Arden Group (ARDNA)
· Blue Nile (NILE)
· Landauer (LDR) – again
· Usana Health Sciences (USNA)
· Bio-Reference Labs (BRLI)
· Computer Programs and Systems (CPSI)
· Advance America, Cash Advance Centers (AEA)
· True Religion Apparel (TRLG)
· CEC Entertainment (CEC)
· WD-40 Company (WDFC)
· Meidian Bioscience (VIVO) – again
· Balchem (BCPC)
· Ebix (EBIX)
· Papa John’s (PZZA)
· World Acceptance (WRLD)
Obviously, a 15% ROE is much easier to achieve than a 15% operating margin. Some of the above companies lack pricing power. They may still be efficient, wide moat businesses. Actually, in Hidden Champions of the 21st Century, Simon focused on German companies so he ended up with a lot of hidden champions in capital goods. As a result, they didn’t always have the fattest margins.
U.S. hidden champions tend to be different. The U.S. doesn’t have the same strengths and weaknesses as Germany. It has a much bigger domestic market. You will tend to find more successful American companies that combine some elements of analysis and marketing prowess than excellence in manufacturing. And you’ll find more American hidden champions with logistical competitive advantages than you will in Germany. This is because the U.S. is a very, very big country in terms of length and width of the land. And it’s surrounded by oceans. Any business that requires on-time delivery and some element of customization or extreme product breadth will allow for the development of a centrally located U.S. hidden champion (or one that slowly moves out across the country in circles of controlled territory).
Also, because the U.S. is so big you get occasional hidden champions – especially in retail – who just dominate a local area. Remember, the biggest grocer in California, Texas, New York, etc., is going to be much bigger than the biggest grocer in most countries. And yet most Americans will not recognize the company’s name.
Because ROE includes the use of leverage – and some companies are unleveraged – there are a few businesses with returns on assets that are high enough to get them into the consistently high ROE group if only they used a normal amount of leverage. Also, some companies have negative equity. A company with negative equity is sometimes a terrific investment. But no matter how profitable the business the company can’t have a positive ROE because the return on equity calculation is net income/equity and if you divide by a negative number it doesn’t matter what the net income number is. To fix this problem you have to screen for companies with at least an 8% ROA regardless of ROE. You’ll find two new names – the others are all repeats of the ROE group – under $100 million in market cap:
· Unilens Vision (UVIC)
· Mocon (MOCO)
And quite a few more between a $100 million market cap and $1 billion market cap:
· Mesa Laboratories (MLAB)
· U.S. Physical Therapy (USPH)
· NVE (NVEC)
· National Research (NRCI) – again
· Atrion (ATRI)
· CorVel (CRVL)
· Exponent (EXPO)
· Lumber Liquidators (LL)
· Neogen (NEOG)
· Arbitron (ARB)
Another good way to look for possible hidden champions – in addition to consistently high operating margins and consistently high returns on assets and equity – is to simply look for small companies that tend to have continuously higher earnings per share. Under $1 billion there are a few companies with that kind of history:
· National Bankshares (NKSH)
· Atrion (ATRI) – again
· World Acceptance (WRLD) – again
There are a couple interesting companies that just miss the $1 billion market cap cut-off for this screen:
· MWI Veterinary Supply (MWIV)
· First Financial Bankshares (FFIN)
· Chemed (CHE)
Researching the stocks on those lists should keep you busy. It’s important not to throw out any of those names purely based on their industry. There’s obviously a reason why they showed up on these screens. Either they have been very good, very lucky – or they actually have some kind of moat.
Some of these stocks are definitely Hidden Champions.
For Hidden Champions in the UK read Richard Beddard’s blog.
The best place to screen for hidden champions in the UK is SharelockHolmes.
If you want to find hidden champions outside the U.S. and UK – tough luck. You’ll probably have to do it the old-fashioned way. I’ve had very little success screening for hidden champions outside of the U.S. and UK. Most global screeners are really bad at this sort of thing. If you know of a screener that can successfully find hidden champions in the rest of the world, let me know.
One tip though: There’s an index in Hidden Champions. And there’s an out of print edition of the book as well. The companies discussed in the two editions are not identical. So, that’s a pretty big list of names you can get just from reading both editions of Hidden Champions.
One last hint. Bloomberg has excellent coverage of worldwide companies and they make it available for free on their website. You won’t find detailed financials. But you can always find out if a company is public, what its ticker symbol is and where it trades just by typing the company name into the search box in the upper right of the screen.
I’ve tried it with ultra tiny stocks on ultra illiquid exchanges in countries with populations less than some cities. It works. If you know the name of a company, there’s no reason you can’t learn whether or not it’s public – and where it trades.
Ask Geoff a Question about Hidden Champions
Check out the Buffett/Munger: Bargain Newsletter
Check out the Ben Graham: Net-Net Newsletter
I recently read the book "Hidden Champions of the 21st Century" by Hermann Simon and I would like to attempt to uncover some of these types of highly entrenched, highly focused, “super-moat” companies. I think this ties in with your “watchlist” approach, and is something you touched on in your Invest with Style piece if I’m not mistaken.
"Hidden Champions" is one of my favorite books. If I could recommend only one book for value investors to read it would be "Hidden Champions." I know people will read Ben Graham, Joel Greenblatt, etc. Most people won’t read "Hidden Champions." And that’s a shame. Because it teaches you a lot of things that you can apply to your investing right away.
The way to know if you have a hidden champion or not is to analyze the business. Not just the past financial record. But there are thousands and thousands of stocks out there – especially in the under $100 million and under $1 billion market cap categories.
Most stocks have a market under $1 billion. There’s a simple reason for that. Most companies will never grow to be $1 billion companies. Reading about Exxon Mobil (XOM) and Apple (AAPL) and Starbucks (SBUX) and thinking you are becoming a business expert is like reading about blue whales and elephants and thinking you are becoming an animal expert. Tiny insects are a lot more common than giant mammals. Hidden champions are a lot more common than global Goliaths. Companies like Apple and Starbucks and Exxon Mobil can only grow up in very special environments.
So, the good news about hidden champions is that they are worth studying. The bad news is that unlike Exxon Mobil, Apple, etc., they do not stand out. You have to find them from among thousands of companies of similar size.
This sounds like a job for a screen.
The results you get from any screen are just a starting point. I am not saying these companies are hidden champions. I’m saying that if you only have a couple hours to devote to company research each week – you can start with this list instead of going through all public companies from A to Z.
As far as specific screens that might help uncover Hidden Champions, here are a few ideas:
1. Companies with 10 years of consistent 15% or higher operating margins and a market cap less
than $1 billion
2. Companies with 10 years of consistent 15% or higher return on equity and a market cap less than $1 billion
3. Companies with 10 years of consistent 8% or higher return on assets and a market cap less than $1 billion
4. Companies with 10 years of consistent earnings per share increases and a market cap less than $1 billion
Number 2 and 3 are really one screen. You need to include an ROA exemption to allow companies with no leverage to be put on equal footing with companies that use leverage. After all, you asked about Hidden Champions – not companies that were necessarily maximizing their return on equity through their financial decisions. Generally, an unleveraged company (outside of financials, utilities, transports, and a few select industries) that earns an ROA equal to half the ROE of a “normally” leveraged competitor has operations that are about equally profitable. In other words, if an ultra-conservatively managed family company earns 10% on equity it would probably earn closer to 20% on equity if it was sold to a professionally managed multinational.
Of companies with an operating margin of 15% or more in each of the last 10 years, only one Noble Roman’s (NROM) is under $100 million market cap. But between $100 million and $1 billion million there are:
· Utah Medical Products (UTMD, Financial)
· Young Innovations (YDNT, Financial)
· National Research Corporation (NRCI, Financial)
· U.S. Ecology (ECOL, Financial)
· Landauer (LDR, Financial)
· Meridian Bioscience (VIVO, Financial)
· Amsurg (AMSG, Financial)
· Mobile Mini (MINI, Financial)
Very few companies consistently post an operating margin greater than 15%. This equates to about a 10% after-tax net margin in the U.S.
A consistent 15% ROE record is easier for companies to pass. Under $100 million in market cap we have:
· Advant-E (ADVC, Financial)
· Psychemedics (PMD)
· Rocky Mountain Chocolate (RMCF)
· United-Guardian (UG)
· Cherokee (CHKE)
Between $100 million and $1 billion we have:
· VSE (VSEC)
· Omega Flex (OFLX)
· PetMed Express (PETS)
· Arden Group (ARDNA)
· Blue Nile (NILE)
· Landauer (LDR) – again
· Usana Health Sciences (USNA)
· Bio-Reference Labs (BRLI)
· Computer Programs and Systems (CPSI)
· Advance America, Cash Advance Centers (AEA)
· True Religion Apparel (TRLG)
· CEC Entertainment (CEC)
· WD-40 Company (WDFC)
· Meidian Bioscience (VIVO) – again
· Balchem (BCPC)
· Ebix (EBIX)
· Papa John’s (PZZA)
· World Acceptance (WRLD)
Obviously, a 15% ROE is much easier to achieve than a 15% operating margin. Some of the above companies lack pricing power. They may still be efficient, wide moat businesses. Actually, in Hidden Champions of the 21st Century, Simon focused on German companies so he ended up with a lot of hidden champions in capital goods. As a result, they didn’t always have the fattest margins.
U.S. hidden champions tend to be different. The U.S. doesn’t have the same strengths and weaknesses as Germany. It has a much bigger domestic market. You will tend to find more successful American companies that combine some elements of analysis and marketing prowess than excellence in manufacturing. And you’ll find more American hidden champions with logistical competitive advantages than you will in Germany. This is because the U.S. is a very, very big country in terms of length and width of the land. And it’s surrounded by oceans. Any business that requires on-time delivery and some element of customization or extreme product breadth will allow for the development of a centrally located U.S. hidden champion (or one that slowly moves out across the country in circles of controlled territory).
Also, because the U.S. is so big you get occasional hidden champions – especially in retail – who just dominate a local area. Remember, the biggest grocer in California, Texas, New York, etc., is going to be much bigger than the biggest grocer in most countries. And yet most Americans will not recognize the company’s name.
Because ROE includes the use of leverage – and some companies are unleveraged – there are a few businesses with returns on assets that are high enough to get them into the consistently high ROE group if only they used a normal amount of leverage. Also, some companies have negative equity. A company with negative equity is sometimes a terrific investment. But no matter how profitable the business the company can’t have a positive ROE because the return on equity calculation is net income/equity and if you divide by a negative number it doesn’t matter what the net income number is. To fix this problem you have to screen for companies with at least an 8% ROA regardless of ROE. You’ll find two new names – the others are all repeats of the ROE group – under $100 million in market cap:
· Unilens Vision (UVIC)
· Mocon (MOCO)
And quite a few more between a $100 million market cap and $1 billion market cap:
· Mesa Laboratories (MLAB)
· U.S. Physical Therapy (USPH)
· NVE (NVEC)
· National Research (NRCI) – again
· Atrion (ATRI)
· CorVel (CRVL)
· Exponent (EXPO)
· Lumber Liquidators (LL)
· Neogen (NEOG)
· Arbitron (ARB)
Another good way to look for possible hidden champions – in addition to consistently high operating margins and consistently high returns on assets and equity – is to simply look for small companies that tend to have continuously higher earnings per share. Under $1 billion there are a few companies with that kind of history:
· National Bankshares (NKSH)
· Atrion (ATRI) – again
· World Acceptance (WRLD) – again
There are a couple interesting companies that just miss the $1 billion market cap cut-off for this screen:
· MWI Veterinary Supply (MWIV)
· First Financial Bankshares (FFIN)
· Chemed (CHE)
Researching the stocks on those lists should keep you busy. It’s important not to throw out any of those names purely based on their industry. There’s obviously a reason why they showed up on these screens. Either they have been very good, very lucky – or they actually have some kind of moat.
Some of these stocks are definitely Hidden Champions.
For Hidden Champions in the UK read Richard Beddard’s blog.
The best place to screen for hidden champions in the UK is SharelockHolmes.
If you want to find hidden champions outside the U.S. and UK – tough luck. You’ll probably have to do it the old-fashioned way. I’ve had very little success screening for hidden champions outside of the U.S. and UK. Most global screeners are really bad at this sort of thing. If you know of a screener that can successfully find hidden champions in the rest of the world, let me know.
One tip though: There’s an index in Hidden Champions. And there’s an out of print edition of the book as well. The companies discussed in the two editions are not identical. So, that’s a pretty big list of names you can get just from reading both editions of Hidden Champions.
One last hint. Bloomberg has excellent coverage of worldwide companies and they make it available for free on their website. You won’t find detailed financials. But you can always find out if a company is public, what its ticker symbol is and where it trades just by typing the company name into the search box in the upper right of the screen.
I’ve tried it with ultra tiny stocks on ultra illiquid exchanges in countries with populations less than some cities. It works. If you know the name of a company, there’s no reason you can’t learn whether or not it’s public – and where it trades.
Ask Geoff a Question about Hidden Champions
Check out the Buffett/Munger: Bargain Newsletter
Check out the Ben Graham: Net-Net Newsletter
