Dorman Products, Inc. - The Value of Patience
One of the things we seldom pay attention to, is our own portfolio. The reason for that is because over the years we have learned there are several things investors need to train themselves to do if they are to be successful over a lifetime of investing.
First of course, is a develop a regular stream of savings. We believe that successful investors pay themselves first. In other words they treat making deposits to their savings plan the same way they treat paying a bill. The difference is, the bill that gets paid first, is their savings plan bill. That rule, in our opinion, should never be broken.
The second thing investors need is time. We believe, and experience has shown, the longer an investment is held the larger the investment should grow. But for that to work, investors must take the time to do a little homework before they buy a stock.
For instance, a few questions that should be asked are; How does the the company earn its money? Does management seem entrepreneurial in their thinking? What is a reasonable value for the stock? To us those are basic questions that should be answered when considering adding a stock to a portfolio.
The third thing we think that is required is patience. Many years ago, we came across an article by Ron Baron, the founder of Baron Capital Management, in which Mr. Baron said that his goal for his clients was to find stocks that would double in price every five years. Wow what a great trick we thought at the time. But we have found that Mr. Baron's goal was very achievable when patience is applied to an investment.
In 2005 we came across auto parts manufacturer Dorman Products, Inc. (Nasdaq: DORM). The economy in 2005 was not bad. Americans were starting to really get geared up to spend money they didn't have by borrowing against houses they didn't own, houses that weren't worth what was paid for them to start with.
One of the things that many people believed they had to have in addition to a new house was a new car.
Dorman Products is in the replacement auto parts business, and serves the automotive aftermarket, a market that was seeing little demand and even less growth in 2005 since the vast majority of spenders were buying new cars not repairing old cars.
But life is like a wheel (pun intended), and what goes around comes around, setting up a good opportunity to take a position in Dorman Products.
Financial information related to Dorman Products, Inc. contained in this report is based on the company's most recent SEC Form 10-K filing for fiscal year ending December 31, 2009, as filed with the Securities and Exchange Commission on March 5, 2010.
What They Do
The company is a supplier of automotive replacement parts, fasteners, and service line products primarily for the automotive aftermarket, marketing 103,000 different automotive replacement parts, including brake parts.
Approximately 21% of the company's parts and 69% of net sales consists of parts and fasteners that were original equipment dealer "exclusive" items at the time of their introduction.
Original equipment dealer "exclusive" parts are those which were traditionally available to consumers only from original equipment manufacturers or salvage yards and include, among other parts, intake manifolds, exhaust manifolds, oil cooler lines, window regulators, radiator fan assemblies, power steering pulleys, and harmonic balancers.
Fasteners include such items as oil drain plugs and wheel lug nuts.
Approximately 90% of the company's products are sold under the company's brand names and the remainder sold for resale under customers' private labels, other brands, or in bulk.
The company's products are sold primarily in the United States through automotive aftermarket retailers such as AutoZone, Advance Auto, and O'Reilly, or through national, regional and local warehouse distributors such as Carquest and NAPA, or through specialty markets and salvage yards.
Through its Scan-Tech subsidiary, the company is increasing its international distribution of automotive replacement parts, with sales into Europe, the Middle East and Asia. In addition, the company is increasing distribution of automotive replacement parts in Canada through its Dorman Canada Business Unit.
The stock closed recently at $23.34 with resistance at $26.00 and support at $21.34. In addition, the trend has recently turned positive. We note that the Stochastic chart shows the stock as being overbought and the MACD shows that the best time to have taken a short-term position was around the first week in July.
With 11% to the upside from its recent close, 9% to the downside from its recent close, and noting the stock appears to be in an uptrend, we think a short-term trade may be the thing to do for those investors so inclined.
However, short-term investors should be aware that should the stock price break through current support, the next level of support isn't until $18.50, a 21% decline from a recent close.
Accordingly, we think short-term investors should place a stop under their trade and continue to adjust that stop in lock step with changes in the stock price.
Long-Term (5 Year Hold) Investment
Of the long-term investment metrics we like to focus on, the majority were what we consider investment quality. For instance, the Current Ratio, Quick Ratio, and Debt to EBITDA ratio were all at investment levels, as were Debt to Equity and Earnings Growth.
What was not acceptable, and it is a metric that always gives us pause, was the Stock to Debt Ratio, a simple metric that compares the capital spent on stock repurchases to the capital spent on reduction of debt.
During FY08, the company spent 7 times more capital on debt reduction than it did buying back company stock.
However, in FY09, the company spent 9 times more capital buying back company stock than it did on debt reduction.
To us, there is simply no excuse for such behavior on the part of management, especially considering that the company does not pay a dividend.
We are incensed that such events are allowed to occur. So much so that we think the fair thing for management to do, is to forgo 100% of their salaries and bonuses until the $800,000 gap between debt reduction and stock repurchases is reduced to $0.00.
In addition, we think management should agree that should such an event be allowed to happen again, not only will they forgo 100% of their salaries and bonuses, they should agree to automatic termination with no severance or termination package, and that such termination would include the loss of any company provided insurance coverage.
Based on our review of the company's FY09 financial information, we believe a Reasonable Value Estimate for the stock is between $39 and $41, which would normally place our Buy Target in the $23-$25 range.
However, because management decided to pat their collective rear-ends and take a victory lap over debt reduction and a gross profits increase, all the while ignoring the common shareholder, we believe there is increased risk to owning Dorman Products stock.
Accordingly, we think a lower Buy Target for new investors as well as those stockholders adding to existing holdings, should be in the $15-$16 range.
We have owned Dorman Products stock since July of 2005 and have a cost basis of $11.34.
Every year we perform a cursory review of the stocks we hold in our portfolio and every five years we take a little closer look at those stocks. Last week, we took a look at Dorman.
The company continues to focus on efficiencies by cutting costs and eliminating waste, events that have become integral to the company's budget process, and ones we view as extremely positive on the part of management.
But along with the positive comes the negative, and it is our opinion that management needs to pulls its hand out of its pants, get its mind back from Arkansas, and focus on eliminating the company's debt, increasing the company's cash, decreasing the company's accounts receivable, and paying company shareholders a dividend before a single penny is wasted buying back company stock.
That aside, we have indeed doubled our invested dollars over the course of our 5 year hold of this stock, something we attribute not only to buying at the right price, but holding the stock long enough for the price we paid to have a positive impact on the return we are receiving.
Tangible proof at least to us, that patience is among the keys to successful investing.
To download the Dorman Products Raw Value worksheet, please click here.