Buying smaller companies is not just about finding under-valued opportunities now but assessing their potential for growth and to deliver compounding returns, says Dan Scott Lintott, Investment Analyst at De Lisle Partners.
Warren Buffett’s recent announcement that he is stepping down as CEO of Berkshire Hathaway, made with just minutes to spare at the end of the company’s famous annual shareholder meeting in Omaha, marks the end of an extraordinary chapter in investment history.
Among his most enduring legacies is the idea that value and growth are “joined at the hip” – a concept that we agree with. While traditional value investing, as taught to Buffett by Benjamin Graham, focused on companies trading below liquidation value which offered a built-in “margin of safety”, Buffett evolved this approach.
His key insight was combining Graham’s hunt for cheapness with the idea that a stock’s ultimate value is the future earnings that the underlying company’s assets can produce. This meant not simply buying companies for less than their asset value, but also ensuring those assets could deliver consistent, compounding returns. Better yet, Buffett identified the value of intangible assets such as well-known brands (e.g. Coke and American Express) that can produce high returns and growth, but only buying them when they are out of favour – “You pay a very high price in the stock market for a cheery consensus”. In other words, a business must be capable of turning assets into cash flow – otherwise, it’s not cheap at all.
This view naturally links value with growth. It’s why some investors – particularly those focused on smaller companies – look beyond low valuations to identify businesses led by energetic management teams whose actions can have large impacts on small companies. A strong team can conservatively compound earnings growth in their core operations while retaining an opportunistic eye for expansion or new avenues for growth. In our own approach, we place particular weight on signs such as meaningful insider ownership, low debt usage and a track record of doing what they say.
These are what we call ‘steady little growers’. The conundrum is that when many agree on the cheeriness of a stock’s growth outlook, it rarely stays affordable. That is why being in overlooked parts of the market, seeking dependable – but sometimes cyclical – growth without the price tag or, more often, derivative beneficiaries of prevailing market themes can provide additional margin of safety.
Today’s backdrop – persistent inflation fears and concerns about slowing growth – has driven up the price of perceived safety. Alongside big tech companies, stocks like Walmart (36x this year’s estimated earnings) and Costco (53x) have delivered remarkably consistent revenue growth, year in year out. The price investors are paying for this straight-line growth is now the highest it has been in the past two decades. Buffett companies perhaps, but not Buffett prices.
Eventually, value will override growth. If the price paid for safety is too high, then it ceases to be safe. From market history, we know that stocks bought at extreme valuation highs lead to lower returns. This makes very high multiple stocks risky as investments despite the safety of the underlying company’s sales and profits.
That’s why the question now is not why the largest stocks are expensive – but whether the small ones are cheap. We believe they are. The market is uninterested in any sales and earnings with perceived cyclicality. These stocks tend to trade at prices we find appealing, as they grow over time but sometimes in fits and starts.
However, cognisant of the weakening outlook for growth and inflation, our preference has shifted further toward attractively priced steady growers – businesses that offer underlying stability. Two examples of these types of businesses include Murphy USA and Carriage Services.
Murphy USA (MUSA)
While fuel sales are cyclical and therefore unexciting, Murphy USA has steadily grown its bottom line. Over the past decade, the company’s sales have compounded at 1.75% annually – modest when compared to Costco at 8.49% – but earnings per share have grown at 17.49%, outpacing Costco’s 13.54%.
The profitability has been supported by a growing contribution from high-margin convenience store sales and consistent share buybacks. When we began building a position in December 2023, Murphy traded at just 13x forward earnings. Even at today’s 17x, it remains attractively valued given its consistent earnings quality and long-term expansion prospects.
Carriage Services (CSV)
Carriage Services, operating in the funeral services industry, delivers as stable a revenue as one might expect. However, the shift toward more affordable cremations adds perceived uncertainty over its profits, helping keep its valued subdued – currently around 13x forward earnings.
With a refreshed management team and board now focused on building relationships with insurers to grow the funeral prepayments side of the business, the earnings have a steadier path to growth. The company’s inherently reliable demand profile, combined with its efforts to smooth profitability, makes it a compelling example of overlooked growth at value prices.
Markets may remain febrile – swayed by political headlines or shifting inflation expectations – but investors focused on the long term and on cheaper, steadier growth stories should take heart. As Buffett showed, true value lies not just in cheapness, but in the enduring ability of businesses to grow earnings over time. In our view, smaller, overlooked companies like Murphy USA and Carriage Services offer precisely that combination: resilience, long-term opportunity, and the potential to be both cheap and safe.
Main image: mike-kononov-lFv0V3_2H6s-unsplash
