Serious Income Potential from this Small-Cap Stock

Ryan Fuhrmann's picture

Friday, May 14, 2010 - 4:54pm

by Ryan Fuhrmann

Investing in small market capitalization stocks is a time-tested approach to beating the stock market. For starters, it is easier for small companies to grow the top line rapidly because new business can have a significant impact on their smaller sales levels. They can also be less bureaucratic, which keeps costs low and allows more sales to fall to the bottom line as profit. And finally, they tend to be less followed by Wall Street analysts, which gives smaller investors a better opportunity to find undervalued companies.

A current opportunity for value investors and income-seeking individuals as well is Eau Claire, Wisc. based National Presto Industries (NYSE: NPK). National Presto operates three disparate business units that each have their own appeal.

The first is most familiar to consumers and consists of selling housewares and small appliances. The products are used in cooking and canning and include Control Master frying pans, deep fryers for hamburgers, pizza ovens and even microwave bacon cookers. To see the merchandise on display, simply head to Wal-Mart (NYSE: WMT), as it accounted for 11% of last year's total company sales.

The second segment couldn't be more different. It sells military products to the U.S. Department of Defense. The business stems from the 2001 acquisition of AMTEC and brought merchandise for niche uses, such as training ammunition and firing devices.

The third division is officially called the "absorbent products segment" and sells private-label diapers. Just like National Presto as a whole, the unit's target market is diverse -- healthcare products firm Medline accounted for 12% of last year's sales in this segment.

In terms of impact on the company, defense accounted for 53% of last year's total company sales of $478 million. Housewares kicked in just over 31%, and diapers the rest. Defense is also the most profitable and made up 60% of total operating income of $91 million. Housewares contributed one third of profits and diapers, which reported its first full year of real profits, the rest.

National Presto's operating margins are substantial -- averaging in the double digits and exceeding 19% of sales last year. Net margins have hovered in the high single digits during the past decade but jumped to 13.1% of sales last year as income taxes temporarily fell.

In other words, despite the seemingly disparate businesses, they are all decently profitable and don't require much capital to maintain and expand. Of the $62.1 million National Presto generated in operating cash flow, it only used $3.3 million on capital expenditures. Another big positive is that all three segments are relatively recession resistant because they are less dependent on the business cycle for sales to hold up.

If annual profit goals are met, management uses the excess cash it generates for a generous dividend payment. The current stated dividend yield is below 1%, but National Presto has paid an extra dividend during the first quarter for at least the past three years. Last year, total dividend payments were $5.55 a share, and payments reached $8.15 a share this year. This equals an impressive annual dividend yield of about 7.5%.

The actual dividend yield is missed by most investors because most web-based financial resources only provide details on the regular dividend payment. Additionally, only one Wall Street analyst currently covers the stock, which means it is underfollowed and thus very likely to go neglected by institutional investors.

At a trailing P/E of less than 12, investors can gain exposure to a highly profitable business with an above average dividend payment at a compelling valuation.

P.S. Investing in dividend-paying stocks is one of the most profitable ways to beat the market. For more on stable stocks that will grow your money with ever-increasing dividends, see Carla Pasternak's latest course, The 5 Rules Every Income Investor Has to Know.

Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.