4 Ways To Profit From The Unsung Power Behind The U.S. Economy
Although most of the financial media is focused on large, public companies with billions of dollars in annual sales, it’s actually the little guy that deserves more ink.
Small to medium-size businesses (SMB), often privately held with less than a thousand employees, play a huge role in terms of job creation and capital spending. According to the U.S. Small Business Administration, SMBs provide 45% of all non-farm economic activity, 40% of all private sector payrolls and employ nearly half of all non-government employees.
So you should consider it to be a big deal when the National Federation of Independent Business (NFIB), which represents these firms, speaks of a noticeable boost in the outlook for such businesses. The NFIB polls its membership base once a month, and in the most recent reading, found that its NFIB Optimism survey rose last month to 96.6, the highest reading in nearly seven years.
Yes, SMB confidence is back to pre-crisis levels.
To be sure, the NFIB survey didn’t note any major change in business activity. Instead, the key boost to the gauge came from an expectation of steadily improving sales and business conditions in the future, which is typically a precursor to stepped-up hiring and capital spending.
Although signs are pointing to the SMB segment providing a tailwind to our broader economy, it had been a profound headwind in recent years. “The pace of recovery in SMB sentiment has lagged that of large business confidence, likely held back by tighter access to loans and concerns around domestic policy items like health care policy and taxes,” write analysts at Goldman Sachs.
Notably, bank lending terms have steadily loosened in recent quarters, and the noisy debate around health care and taxes has quieted down, at least for now. SMB owners need a quiet economic backdrop to move ahead — and now they have it.
For investors, it’s time to focus on the companies that derive a significant portion of their sales from SMBs. Here are four solid candidates that hold appeal for further research.
| 1. Endurance International Group (Nasdaq: EIGI ) |
| This company helps SMBs build and operate and develop cloud-based sales platforms. Everything from Web hosting to e-commerce fulfillment to site security is offered on a subscription-based operating model. EIGI only began operations in 2010, so we don’t know how the company would have fared during previous economic cycles. But even before SMB confidence grew, sales had already managed to surge from $88 million in 2010 to $520 million in 2013 and are headed to $730 million by next year, according to analysts’ consensus forecasts. |
| 2. ScanSource (Nasdaq: SCSC ) |
| This company plays a vital role for SMBs, as it resells a range of products from major manufacturers that typically only deal directly with large clients. ScanSource sells barcode scanning equipment, point-of-sale devices (such as credit card scanners and cash registers), security/surveillance equipment and communications equipment such as Internet-based phone networks and Wi-Fi routers. The company’s deep and established base of customers helps ScanSource appeal to new companies and new technologies that want to crack the SMB market. For example, 3D Systems (NYSE: DDD) recently announced plans to sell through ScanSource. To be sure, ScanSource’s exposure to the economically sensitive SMB segment means that growth can be bumpy. Indeed, the fact that SMB confidence has been low in recent quarters means that SCSC’s sales were likely stuck at around $2.9 billion in fiscal (June) 2014. But if history is any guide, then the now-rising level of confidence among SMBs should yield higher sales. Back in the middle of the last decade, when SMB confidence was high, ScanSource’s sales typically grew at a 15% to 20% annual pace. |
| 3. Lamar Adverting (Nasdaq: LAMR ) |
| This company owns roughly 38,000 billboards across America’s highways and byways and counts on locally owned SMBs for an estimated 80% of its revenue. A transition to digital-based billboards, which can show video or any other timely messages, is helping to boost margins. And for yield-seeking investors, Lamar has recently changed its corporate status and is now a real estate investment trust (REIT). The company offers a regular dividend of $2.50 a share, though a recent special dividend boosted the payout to $3.32 a share, equating to a 6.5% yield. Lamar generates robust free cash flow, so analysts are modeling for respectable dividend growth in the years ahead. |
| 4. United Rentals (NYSE: URI ) |
| This company owns and leases the kind of heavy equipment that may only be needed a few times a year for major projects. For many SMBs, it’s far cheaper to simply rent out URI’s construction equipment, forklifts, power tools and other such wares. Even before the long-awaited upturn in SMB confidence, URI’s growth has been impressive, helping sales to more than double over the past three years (to just shy of $5 billion in 2013). Analysts expect sales to rise at a more modest 10% pace in 2014 and 2015, and shares trade for a reasonable 13 times projected 2015 profits. |
Risks to Consider: The next SMB confidence reading from the NFIB will come in early July, and if you are invested in these stocks, it pays to keep monitoring this key confidence gauge to be sure there hasn’t been any slippage.
Action to Take –> Rising spending by SMB acts as a powerful growth engine for many other parts of the economy. For example, many small towns count on them as the major employer in the area, and as they spend more, the entire local ecosystem sees more spending on local retail shops, diners, and so on. These four companies, all of which derive the bulk of their sales from SMBs, all provide solid exposure to this emerging economic bright spot.
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