Why Haven't You Bought This Stock?

Some stocks just don't seem to attract the attention they deserve. If its not a headline-friendly business, or something that sells products with an "i" in front of their names, the majority of investors and analysts apparently don't want to hear about it. Luckily for the diligent stock hunter, this creates opportunities across the board. This franchiser of secondhand stores is one of the least sexy companies around, but has been killing it quarter after quarter, year after year. The most recent earnings release shows a healthy, cash-printing business that can only encourage shareholders and may entice those who are seeking a growing company with a decent dividend. Are you ready to add Winmark to your portfolio?

A+ report
Winmark (NAS: WINA) is not on many an investor's radar. It's a boring business that rarely makes it into the news. The company operates in two segments: It franchises secondhand stores and provides business leasing services to small and midsize organizations. While the stores aren't found in your average mall, you may recognize some of the names: Plato's Closet (women's clothing consignment), Play It Again Sports (used sporting equipment), Once Upon A Child (used kids goods), and Music Go Round (secondhand musical instruments).

The company does not operate the stores, it simply finds people who want to open a branch and provides them with the infrastructure. The business owners then pay royalties on sales back to the company. As of the beginning of this month, there were a total of 958 stores under the various names.

It's a great business to be in, and this company knows how it's done. The company brought in nearly $10 million in royalty payments last quarter. Leasing income, derived from a $34 million portfolio, brought in an additional $4.3 million. Both figures are a nice premium to the year-ago results, and contributed to beating analysts on both top and bottom lines. Total revenue was approaching $15 million, up from $11.7 million the year before.

The chairman and CEO of Winmark, John Morgan, is a veteran of the business and has proved to shareholders his ability and faith in the company. He holds over a million shares of the common stock, and has been consistently buying open-market shares this year between $50 and $58 per share. The stock currently trades at around $53.70.

Despite all of this seemingly good news, the stock didn't really budge after its earnings release late last week. So what gives?

What gives
Winmark has made some errors in its equity investments, resulting in losses the last few years. For this quarter, John Morgan laid out the most recent effects on the company's bottom line:

"During the quarter, our pre-tax income was reduced by approximately $1.0 million, or $0.20 per share, due to our share of losses from Tomsten, as well as an impairment charge relating to our investment in BridgeFunds, L.L.C. This compares with a reduction of pre-tax income during the third quarter of 2011 from these investments of $0.5 million, or $0.10 per share."

Was this enough to keep investors from buying into the overall strong report? It's hard to say. For a nearly $300 million company, you certainly don't want to see investing losses in the millions, but the company was still able to beat analysts and post strong gains over the prior year. To me, it seems unlikely this hiccup was the culprit.

Pay attention
I understand this isn't a very fun business to read about, but the downsides to the company are few: limited liquidity, very little analyst coverage (in my opinion, a good thing), and the eventual retirement of John Morgan, who is 70 years old. But let me be perfectly clear about what makes this such a strong investment:

  • It's a franchise business. Just ask Bill Ackman: Franchises are phenomenal businesses to invest in. The parent company shifts some risk to the individual business owner, and just watches the royalty checks come in. You know how this works with everyone's favorite burger stock, McDonald's. The business operates more like a REIT than anything else. Winmark has almost 1,000 stores, and nearly 60 more on tap. The stores themselves do well in booming economic times as well as down times, when more people seek out bargain deals.

  • It has a strong complementary business: With the cash from the franchise business, Winmark funds its business leasing service. This includes the franchisees, who may need some extra capital to get off the ground, as well as other small and midsize companies in need of money or services. John Morgan used to do this exclusively, before Winmark, and sold the company for a bundle after a very successful run.

  • It's cash, cash, cash. Royalty checks come in as cold, hard cash. There are no receivables. Some of that cash goes into leasing, which in turn yields interest income -- again in the form of cold, hard cash. Cash-flow-rich businesses are my favorite businesses (and often favorites of Warren Buffett), and this one fits the mold to a T.

The company has some debt on the books, mainly in the form of a $10.7 million line of credit, but its of little to no concern to me given the strength of the business. If you have a dissenting opinion, please share in the comments below.

Winmark has witnessed a near 200% return in stock price over the last five years. The last year returned around 11%, and nearly 20% with dividends reinvested -- not too shabby. It's not a bargain stock, and usually I will dismiss anything that isn't selling at a substantial discount to intrinsic value, but I just love this business and will continue to do so until someone proves me wrong.

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The article Why Haven't You Bought This Stock? originally appeared on Fool.com.

Fool contributor Michael B. Lewis has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services recommend McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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