Great Companies in Lousy Industries: Finding Hidden Winners

Book: Beating the Street by Peter Lynch with John Rothchild | ISBN: 978-0-671-75915-5

Peter Lynch would rather invest in a boring, struggling industry than a hot, growing one. That sounds wrong. But he has decades of results backing it up.

Hot industries attract too much competition. Everyone piles in, margins get crushed, and nobody makes money. Yogi Berra once said about a famous restaurant, “It’s so popular, nobody goes there anymore.” Lynch says the same thing happens to exciting industries. When everyone wants in, the profits disappear.

In a lousy industry, the weak players drop out. The survivors grab a bigger share of the market. A company that captures more and more of a slow or stagnant market is often better off than one fighting to hold onto a shrinking piece of an exciting market.

That’s Peter’s Principle #16: In business, competition is never as healthy as total domination.

What Great Companies in Lousy Industries Look Like

Lynch identifies a pattern. These companies share specific traits.

They are low-cost operators. They pinch pennies in the executive suite. They avoid debt. They reject corporate class systems where executives live in luxury while workers get squeezed. Their employees are well paid and have a stake in the company’s future. They find niches that bigger companies overlook. And they grow fast, often faster than companies in trendy industries.

The reverse pattern also holds. Fancy boardrooms, bloated executive pay, demoralized workers, and heavy debt go hand in hand with poor performance.

Southwest Airlines: The Anti-Airline

In the 1980s, the airline industry was a disaster. Eastern, Pan Am, Braniff, Continental, and Midway all went bankrupt. But Southwest Airlines stock went from $2.40 to $24 during that same period. A ten-bagger while the industry burned.

Why? Mostly because of what Southwest didn’t do.

It didn’t fly to Paris. It didn’t serve fancy meals. It didn’t borrow too much money to buy too many planes. It didn’t overpay executives. And it didn’t treat workers badly enough to make them resent the company.

Southwest was the lowest-cost operator in the industry. Its cost per seat mile was 5 to 7 cents when the industry average was 7 to 9 cents. It found a niche in short-hop flights and called itself “the only high-frequency, short-distance, low-fare airline.”

CEO Herb Kelleher set the tone. His office was decorated with turkeys. Annual gatherings were chili cookouts. Pay raises for executives were capped at the same percentage the regular workforce got. Once a month, all the top executives worked as counter agents or baggage handlers. Stewardesses wore jeans and sneakers. Safety announcements were delivered as rap songs.

Southwest was the only U.S. airline that made money every year since 1973. As competitors faltered and cut routes, Southwest expanded into the gaps. That’s what happens when a great company outlasts a lousy industry.

Bandag: Retreads in Muscatine, Iowa

What could be less exciting than making retread tires in Muscatine, Iowa? Only three analysts even followed this company. CEO Martin Carver held the world speed record for a diesel truck and thanked his family in the annual report. Wall Street barely knew Bandag existed.

The stock went from $2 to $60 in 15 years. Bandag controlled about 5 million of the 12 million retread tires replaced each year in the U.S. It increased its dividend every year since 1975. Earnings grew at 17 percent annually since 1977.

Lynch calls Bandag “the Southwest Airlines of retreads.” Earthy management. Devoted penny-pinching. An unusual niche in an otherwise brutal business.

Cooper Tire: Old Cars, New Tires

While Michelin, Goodyear, and Bridgestone were ruining each other fighting for new-car contracts, Cooper Tire stayed out of their way. It made replacement tires for old cars. Different market. Different economics.

Cooper was a low-cost producer, which is why independent tire dealers liked buying from it. Earnings increased every year from 1985. When the market crashed in 1987, the stock dropped to $10. During the Saddam Sell-off, it fell to $6. Both times it recovered and then some. By the time Lynch wrote about it, shares were at $30.

Green Tree Financial: Last One Standing

The mobile home loan business was terrible. Sales declined every year since 1985. Borrowers were abandoning their trailers and leaving notes for lenders: “our trailer is your trailer.” Not a lot of resale value in a 10-year-old double-wide.

Green Tree Financial stuck it out. Its biggest competitors all gave up. Valley Federal made $1 billion in mobile-home loans, lost money, and fled. Citicorp, the biggest lender of all, walked away too.

Forbes ran a negative article in May 1990 with the headline “Are the Tree’s Roots Withering?” The stock was at $8. Investors who bought right after reading that article tripled their money in nine months.

With no competition left, Green Tree had the entire market to itself. It started packaging loans and selling them, making home improvement loans, and financing motorcycles. Lynch uses Green Tree to show that even an OK company in a lousy industry can do well once the competitors vanish.

Dillard, Crown Cork & Seal, Nucor, Shaw Industries

Lynch walks through four more examples, each one following the same pattern.

Dillard is a department store run by a 77-year-old and his son out of Little Rock. They pinch costs, treat employees well, adopted computers early, and avoid glamour markets. They expand by picking up discarded divisions of bankrupt competitors. A $10,000 investment in 1980 turned into $600,000.

Crown Cork & Seal makes cans. Soda cans, beer cans, paint cans, pet food cans. The executive suite is an open loft above the assembly lines. Its expense-to-sales ratio was 2.5 percent when the industry average was 15 percent. The annual report had zero photographs.

Nucor makes steel. While Bethlehem Steel and USX tested shareholders’ patience for 12 years, Nucor went from $6 to $75 since 1981. There’s no executive dining room, no limos, no corporate jet. When profits drop, everyone from the CEO to the floor worker takes a pay cut. When profits rise, everyone gets a bonus. Workers can’t be laid off and their children get college scholarships.

Shaw Industries makes carpets. In 1961, when the Shaw brothers started, 350 new carpet makers were revving up their looms. Then in 1982, homeowners rediscovered wood floors and half the top 25 manufacturers went bankrupt. Shaw survived as the low-cost producer. The stock went up 50-fold since 1980. The founder hung a banner behind his desk that read: “Maintain sufficient market share to allow full utilization of our production facilities.” Not exactly inspiring. Very effective.

The Pattern

Every one of these companies did the same things. They kept costs low. They treated employees fairly. They avoided debt. They found a niche. They waited for competitors to self-destruct. And they bought back their own shares.

The stocks were cheap because nobody on Wall Street wanted to talk about retreads, cans, carpets, or mobile home loans. Low expectations meant low stock prices. And low stock prices meant opportunity.

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