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Smack in the middle of America’s richest county of Fairfield, Connecticut a select group of “private equity” managers are buying up cash generating companies and using the proceeds to pay investors more than 8% annually in dividends.
That’s a very attractive yield, whether you’re an income or a growth investor. Especially since growth in this corporation’s subsidiary businesses has powered shares 85% higher over the past three years.
The company is Compass Diversified Holdings (Nasdaq:CODI), and I rate the stock a buy anytime the yield is above 8%, which it is today.
Compass functions like a private equity firm. It acquires middle market businesses – those with enterprise values between $50 million and $250 million – and works with the acquired companies to improve competitive advantages, grow market share and profitability.
It tends to focus on companies that are owner-managed and have excellent growth prospects, but lack the funds or experience to get to the next level.
From a shareholder’s perspective, Compass provides a great example of a publicly traded small cap stock that generates superior returns for buy and hold investors.
It’s been a long-term holding in my 100% Letter advisory, and we’re currently up 86%. The position is outperforming the Russell 2000 by 21.6% since I added it three years ago. Of that 86% gain, 36% is from dividend payments and 50% is from capital gains.
There are several benefits to the private equity business model. A portfolio approach provides the benefits of diversification in one investment. And multiple companies generate stable cash flow, which supports a high dividend yield.
Investors are also able to get exposure to great companies that aren’t publicly traded but are extremely attractive investments.
There are also a number of differences between Compass and a traditional private equity firm.
Compass is extremely transparent – pull up its latest 10-K annual filing and you’ll learn more than you probably care to about its subsidiary companies.
It is also open to retail investors since it trades on the NYSE. And it isn’t over leveraged – it typically funds operations and acquisitions with cash and with a dedicated credit facility, rather than through excessive long-term debt. This allows the company to focus on opportunistic acquisitions without having to adhere to unfavorable financing terms from heavy-handed lenders.
Compass will sell a business if it believes that doing so will create more value than can be created in house. Typically these sales generate significant profits and free up capital that was tied up in the subsidiary. The proceeds can then be used to retire debt, invest in Compass or other subsidiaries, or cycle into a new acquisition.
The latest example of this is Fox Factory Holdings (NYSE: FOX), a Compass subsidiary that the company took public this year.
Compass’s dividend policy is to pay shareholders regular, quarterly cash distributions. When you buy shares of Compass you become a partner in the business and you’ll receive the appropriate form K-1 at tax filing time.
The company’s most recent purchase was Clean Earth Holdings, a Pennsylvania-based provider of environmental clean-up services. The industries it typically serves include oil and gas, infrastructure, power and construction. And services typically involve cleaning up, treating and properly disposing of contaminated soil, hazardous waste and drill cuttings.
Moody’s gave the deal its stamp of approval, saying that the deal improves operating performance, and is consistent with its acquisition strategy. I agree.
Compass isn’t an aggressive buy right now. But for buy and hold investors, this 8.3% yielding “private equity” fund can be purchased in moderate amounts whenever the yield surpasses 8%, as it does today.
If you’re not interested at today’s price, I suggest adding the stock to your watch list to buy at a later date.
Also, if you’d like to discover one telltale signal that predicts which stocks are ready to soar 190%, 484%, and 495% in 2014, then come join me at 100% Letter.