Expertise lends distributor competitive advantage

Last week's examination of Solid State's business performance since 2005 bolstered its credentials as a growth stock. The distributor of specialist electronic components, battery packs and rugged computers has grown profit margins while keeping leverage level. The result: shareholder wealth compounding at 13% a year.

The doubling of its share price since it's been in the Thrifty 30 portfolio has extinguished its value credentials though. Its earnings yield is about 7.5%, significantly less than the 10% I usually require for a new investment. Since I'm a value investor, not a growth investor, the loss of value caused by the increasing cost of the shares, is more worrying than the validation of its growth credentials.

Of course Solid State may well continue to grow, and if it does, the company will be worth more. I'd prefer to take the money and put it in another company, though, one that doesn't need to grow to justify its inclusion in the portfolio.

By keeping my expectations so low, it makes it easier for companies to meet them.

But before I decide to keep Solid Sate, or eject it from the Thrifty 30, a short homage.

It's in a competitive business, distributing IT, and it's profiting, something that fellow Thrifty 30 member Northamber, also a distributor, finds it very hard to achieve. Perhaps there are lessons in Solid State's success for other companies in competitive businesses, during hard economic times.

Unlike Northamber, which sells computers and peripherals to small businesses, Solid State, has invested, restructuring and relocating its businesses, and acquiring new, specialised businesses.
Solid State has a much deeper capability to customise, design and manufacture products according to the bespoke needs of its customers, which are typically complex, because its computers, batteries and components are used in harsh industrial environments.

The company's technical know-how probably gives it a competitive advantage that makes customers and suppliers want to do business with it, and allows it to charge a premium. Time will tell, but it could be a micro-hidden champion.

Solid State has evolved since its flotation on the Alternative Investment Market in 1996  from component distributor to niche 'value-added' distributor and manufacturer and there may parallels in recent developments at Holders Technology and its shift into lighting. For decades Holders has distributed components for Printed Circuit Boards to manufacturers but during the credit crunch it used its knowledge of Light Emitting Diodes (one of the industries its PCB business serves) to acquire a small distributor and enter what might become a more lucrative business. Holders is also serving the portfolio very well.

There are parallels with XP Power too, a distributor that turned itself into a manufacturer of power supplies and has enjoyed a tremendous run on the stock market. XP Power had the briefest of sojourns in the Thrifty 30, but it may well be the portfolios best ever investment on an annualised basis.

These situations present me with a huge dilemma. As a value investor I seek out stable businesses, whose past records are likely to be indicative of their future performance. Change is risky. Yet change is sometimes needed if a company is to get out of the mire that has driven its share price so low.

Sometimes I find myself in the apparently ludicrous position of assuming no growth, which is the implication of using the earnings yield or price earnings ratios as a rigid yardstick, and at the same time expecting that something will happen to enable the company to grow, because that's where the really big returns will come from.

In fact, the no-growth assumption is protection. I'm saying I don't know if the company is going to grow or not and therefore, because the return on investment is inversely linked to the price you pay, it makes no sense to pay a price that assumes a company will grow.

And so I come to the bittersweet moment, sad but triumphant, when Solid State leaves the portfolio.

Solid State's price is just touching the all time highs it reached in 2000, the shares cost the portfolio ''999.75 and after two years I sold them for ''2,281.25 after costs. Along the way Solid State paid the portfolio an additional ''175.50 in dividends. All these amounts are notional, as the Thrifty 30 is a model portfolio.