Just a few days ago, I noticed a company that really spoke to me and reminded me of a company that Warren Buffett purchased in 2007. I’m going to share my investment thesis for this company below, and what I feel are the key elements to this investment. I really hope you find this information useful.
Business Structure & Description
Back in the year 2007, Berkshire Hathaway purchased 60% of a company named Marmon Holdings. They paid a total of $4.5 billion for this purchase. The reason why this company was so appealing to Buffett is that it’s very similar to Berkshire Hathaway as far as management structure is concerned. The company has 150 subsidiaries, but each subsidiary operates like it is a private independent company. The parent company provides the supporting services such as legal, tax and accounting issues, as well as other pertinent services. When the subsidiaries of Marmon generate excess cash, that money goes to the parent company to appropriately allocate it where it’s needed.
Dover, ticker symbol DOV, is a conglomerate worth $11.5 billion in the industrial business, and this company has 33 separate businesses which employ a total of 34,000 people collectively. Just like Berkshire Hathaway and Marmon Holdings, the structure of Dover is absolutely decentralized, and each subsidiary is its own independent company that has its own Board of Directors and President.
Over the years, Dover has had an average EPS of 16% annually, and it has a wide business moat, which is very important to its overall success. There are two main components to the moat: the decentralized management structure and the acquisition culture of Dover.
Let’s take a look at Dover’s requirements and attributes for each target acquisition:
- Each company must be a manufacturing business of industrial components that add high value or they create systems where the performance is critical to customers and the markets that have high barriers to enter.
- Within the niche, they have to be either number one or a strong number two. They also need to have longer product life cycles, and there revenue volatility should be low or moderate.
- Each company must have a broad customer base of consumer users or industrial users. They also need very attractive recurring revenue products or services.
- The company must focus strongly on ethical customer relationships, and have an intimate knowledge and understanding of all their customers.
- They must possess a strong distribution network, and either have global distribution in place, or the potential to do so when needed.
- There must be strong growth potential, and each company must have an EBIT of 15% or higher.
The criteria listed above for each business that’s going to operate as a standalone company is imperative if it’s going to be a Dover acquisition. There are going to be times when Dover will acquire a business, or a product line, and use it as a way to strategically strengthen another one of its existing businesses. When they make acquisitions like this, they typically refer to them as “add-ons”. The majority of Dover acquisitions are purchased with cash.
The acquisition strategy in question ensures that every Dover addition will strengthen the competitive position of the group, as well as increase their potential for overall growth.
The second main component of Dover’s moat is the structure of its management. Dover has the exact same mentality for management as Warren Buffett, as well as the Pritzker family, who are the previous owners of Marmon Holdings. Here it is:
Dover’s goal is to purchase businesses that already have great management teams in place. The culture and philosophy of Dover expect the operating management team to handle development of products, handle all of the customer relationships and operate the company as if they personally owned it. Dover will assist all individual entities by leveraging the strength of the overall organization (regional infrastructure, people in leadership development, global sourcing and other support related services). They have financial incentives for the long term, which will encourage each entity to continue to grow their business prosperously.
They believe that the way they judge the ethics, skill, energy and compatibility of each individual’s top executives for acquisition candidates is one of the main factors that they use in their decision-making process.
Dover purchases companies for their long-term acquisition, and they focus on growing their global platforms. They do not operate under the portfolio mentality.
The decentralization in place gives them the much-needed flexibility for every business under the Dover umbrella to adjust to the needs of their customers. It also provides them with the ability to stay on top of all of the developments in their industry. As well, the structure of decentralization removes any integration risk for companies that are newly acquired. Since the majority of the companies acquired retain their own management teams and business culture, integration will not cause any type of disruption to Dover or any of its subsidiaries, no matter how big the acquisition might be.
What Exactly Is Dover Worth?
The management guidance provided by Dover for the year 2013 is an organic growth of 3% to 5%, a growth in acquisitions of 4% and an estimated earnings per share of $5.05 to $5.35.
Dover has consistently met all of its targets, and it has provided great shareholder value for many years. However, I plan to use the lower end of its organic growth projection and assume that their expected growth is only going to be about half of what they think. That in turn provides us with a 5% rate of growth for the year 2013. Their management estimates that they will reach a growth of 7% over the long term, but that number should also be cut to 5% in order to play it safe.
I’m not making all of these discounts based on management expectations because they aren’t honest or trustworthy. This is just a way to give a much broader margin of safety and error, and also take into account that the large size of Dover might be a hindrance to their overall growth over the next decade.
By taking into account all of these assumptions for a long-term growth of 5%, if an investor is looking to earn 100% on his investment over the next 10 years, he shouldn’t pay any more than 13 times forward earnings.
Essentially, Dover is a collection of businesses in the manufacturing arena, and the management of this company has a great track record of allocation of capital. They also have an extremely wide business moat that will protect the company’s revenue and margins of profit in case any type of adversity appears, and this also helps ensure predictable and stable returns throughout the years.
At the current stock price of $65 per share, or maybe a little more or less at the time you are reading this, we are exactly at the fair value estimate of 13 times its estimated five-dollar earnings-per-share during 2013. As an investor, if you were to buy this stock at this price, you will most likely enjoy 10% or more annualized returns over the next 10 years.
This is a nice return to have, and if Dover continues on the path to allocate earnings efficiently, which they have done this whole time, then there is a very good chance that your investment will grow over 100% during the next 10 years.
I actually don’t recommend that you buy Dover right now. It’s a good idea to keep this on your watch list, do some further research on your own to strengthen your conviction in the company, and then let a 10% to 20% decline drop the earnings to 10 to 11 times the 2013 projected profits.
This will provide you with a much greater margin of safety and protect your capital just in case something goes wrong, with the economy itself or the company in general.