1 Unstoppable Multibagger Up 1,280% Since 2011 to Buy and Hold Forever

One of my favorite types of stocks to find are companies that hold leadership positions in niches that are off the beaten path. Often holding a market share no. 1 or no. 2 in these smaller corners of the industry, these companies sometimes have a larger moat than expected because potential competitors have little incentive to disrupt such diminished areas.

Federal signal (FSS 1.02%) is a perfect example of this concept. It makes “vehicles and equipment serving the maintenance and infrastructure end markets” along with public safety equipment. However, Federal Signal is not content with just maintaining its leadership position in its niche markets.

By acquiring high-quality companies in adjacent verticals similar to its existing lines of business, Federal Signal has become a 13-baggage number since 2011. With the company’s stock price recently down 14% from its all-time highs, here’s that now might be the time to consider buying.

Meet Federal Signal

To better understand what exact product areas Federal Signal covers, let’s look at its two business segments:

• Environmental Solutions Group (83% of sales): Product categories in this segment include vacuum trucks (also known as safe digging trucks), street sweepers, industrial cleaning, dump bodies and trailers, multi-purpose maintenance vehicles, marking road, base metal extraction and aftermarket. Management believes it has the No. 1 market share in North America in all of these verticals except industrial cleaning, where it is the second largest.
• Safety and Security Systems Group (17% of sales): Federal Signal’s smaller unit sells products such as public safety equipment (lights on a police car, for example), signaling and warning systems. Again, the company has a market share of no. 1 or no. 2 in each vertical.

While Federal Signal generates 41% of its sales from the cyclical industrial sector, it is able to offset these fluctuating sales somewhat because an even greater 51% of its revenue comes from publicly funded sources such as governments.

Making the company even more resilient is the fact that its aftermarket vertical is its largest line of business, accounting for 27% of revenue. Consisting of parts and service, rental offers and sales of used equipment, Federal Signal’s aftermarket business adds valuable recurring maintenance and equipment-as-a-service revenue to customers who are not yet ready to purchase new products.

Meanwhile, the company’s second-largest unit, vacuum trucks — which account for 22 percent of sales — is benefiting from the continued adoption of safe excavation practices in North America. While only 19 states had adopted safe digging as a best practice as of 2020, more appear to be in the pipeline. Using vacuum excavation from air or pressurized water to dig, as opposed to bulldozers, shovels or mechanical excavators, safe digging is greener, less damaging to infrastructure and less dangerous.

However, as promising as the company’s two largest sub-segments are, Federal Signal isn’t resting on its laurels, having made 11 acquisitions since 2016, expanding into new verticals as it goes.

Image source: Getty Images.

High-quality acquisitions fuel Federal Signal’s growth

Leaning in its acquisition ways, Federal Signal looks for niche market leaders at reasonable prices — either by product, geography or end market — that can deliver “cycle-cycle margins in line with or greater than current target of the company”.

A great example of company growth through mergers and acquisitions (M&A) was the 2021 acquisition of Ground Force Worldwide for $45 million and the 2022 purchase of TowHaul for $46 million. By combining these two new businesses, Federal Signal has become a leader in the metal mining and support equipment niches, which could grow rapidly due to the continued shift to electric vehicles (EVs). Since EVs average six times the size of traditional internal combustion vehicles, the company shouldn’t see a shortage of business anytime soon from its new adjacent business line.

Similarly, Federal Signal’s most recent acquisition of parts-free vehicles for $54 million last year moved the company into another complementary business sub-segment focused on snow and ice equipment, tree care and vegetation .

Currently generating a return on invested capital (ROIC) of 15% against a weighted average cost of capital (WACC) of 10%, the company creates value for shareholders, generating huge returns compared to debt and equity. Since 51% of Federal Signal’s cash from operations has been directed toward M&A since 2021, the company is proving to be a competent acquirer.

With sales growing 10% annually over the past decade — and management targeting low, double-digit growth going forward — expect more of the same M&A prowess from Federal Signal.

A dividend producer that trades at a fair price

Doubling its dividend payments since 2014, Federal Signal has proven to be a promising dividend growth story. Although it only pays a dividend yield of 0.5%, the company’s payout ratio is just 15% – meaning it could triple its payout and still have plenty of room left for M&A.

While Federal Signal’s price-to-earnings (P/E) ratio has risen steadily since the pandemic, its current score of 26 is roughly equal to S&P 500average of 27.

FSS data PE Report of YCharts.

Following the 14% decline in the company’s price, this mid-market valuation seems fair for a company with a proven track record of generating multibagger returns through its M&A focus on niche industries. An investment in Federal Signal appears to be an excellent long-term proposition that offers a small but rapidly growing dividend.