One year ago in the October 2012 issue of Investor Advisory Service, we joked about the Federal Reserve’s never-ending Quantitative Easing program. Originally intended as a quick fix to recapitalize bank balance sheets after the downturn left many “too big to fail” institutions teetering, Quantitative Easing became a crutch in the stubbornly soft economic recovery that followed the downturn. Put simply, the financial system immediately became addicted to easy money.
As the first round of QE came to an end, the Federal Reserve feared that winding down its bond purchases would produce contractionary monetary policy at a time when the economy was still too weak to grow on its own. The Fed’s answer to that dilemma came in the form of “QE 2,” which later gave way to “Operation Twist,” or QE 3. Eventually, the Fed admitted what everybody had guessed, that QE would continue indefinitely as long as the Fed deemed necessary. We deemed this open-ended money-printing policy “QE 3, 4, 5…” Other market commentators call it “QE Infinity”—same idea.
For investors, one happy consequence of all the money-printing has been a steady melt-up in stock prices. Here at the IAS, we love a bull market, but we worry when the market’s gains outpace the underlying performance of its component companies. A year ago, we summed up our position as follows:
It is a challenge to invest during a period of rising stock prices accompanied by tepid economic growth, both domestically and around the world. Until we become convinced that meaningfully stronger economic growth is coming, we believe that it is best to focus on companies that can continue to succeed in a period of slow economic growth.
Let’s take a look at one of the companies we featured a year ago, HEICO (Ticker: HEI), which has admirably met the challenge of growing its business in the midst of a low-growth economy. HEICO mainly sells replacement parts for aircrafts. Although we’re not wild about the cyclicality of the aerospace market, demand for replacement parts tends to be pretty steady. One thing we do like about the aerospace industry is that it seems to hide a lot of little niches within it, where competition is thin and leaders can earn high margins. HEICO likes to go exploring in all those niches for acquisitions, which are a major source of growth for the company. As an acquisitive business grows, it has to look for larger and larger targets to keep moving the needle. HEICO is still small enough to grow by picking off small targets. The company’s organic growth has been solid, fluctuating between 6% and 18% in recent years. We modeled the potential high price as $75, with a potential low price of $25.50. Based on a price of $35.68 a year ago, the upside/downside ratio was 3.9 to 1.
We really picked a gem with this one. While the S&P 500 lost about 5% from the time we went to press until mid-November, HEICO increased more than 6%. When the market then turned up, HEICO took off like a rocket. The company’s financial results took some time to catch up to the share price. The first fiscal quarter of 2013 produced only 2% sales growth, with lower profits than the comparable year-ago quarter, but management said business was on the upswing, and investors seemed to give the stock full credit for the promise of better times to come. Q2 did not disappoint. Sales increased 10%, 8% organically, with EPS up 22%. Management raised its full-year guidance. As often happens in the stock market, investors who waited for proof of the improving trends missed a lot of the stock’s upside. The share price had already increased 46% since our original feature.
HEICO recently reported Q3 results, with both sales and EPS up 18%. Organic growth was 10%, not bad for an economy growing in the range of 2% annualized! At a recent price of $62.97, plus a $2.20 special dividend paid in December 2012, HEICO has produced an 82% gain in the past year. The S&P 500’s total return has been 19%. Note that HEICO has two classes of shares, regular shares and “A-shares.” The A shares trade at a discount and do not carry voting power.