Over the past year, shares of Gentex Corporation (GNTX) are down about 6%. I think the shares represent great value at these levels, and I believe investors would be wise to buy at this time. I’ll go through my reasoning below by looking at the financial history here and by looking at the stock itself as a thing distinct from the business. I’ll model what I think is a reasonable (and conservative) future price based on dividend history, and I’ll conclude with an appeal to authority.
About the Company
Automotive applications are the largest segment of Gentex’s business. In particular, it manufactures interior and exterior electrochromic automatic-dimming mirrors and electronic components, all with the aim of improving the driver’s visibility. The mirrors can include other electronic components, like compass, microphones, HomeLink, lighting and other components. The company absolutely dominates the electrochromic industry, with 93% of market share worldwide. This might be explained by the fact that the firm has won a number of awards from its customers, including GM Supplier of the Year, Ford Excellence Award, Hyundai Supplier of the Year, and so on.
(Source: Company presentation, August 2018)
In addition to its impressive auto business, Gentex is the only manufacturer currently selling dimmable windows to the aerospace industry, as the firm is the sole supplier to the Boeing 787 Dreamliner series of aircraft, per the 10-K.
(Source: Gentex 10-K, pp. 5)
The company also manufactures photoelectric smoke detectors and alarms, along with other safety equipment (carbon monoxide alarms and the like), and sells these products directly to fire protection and security product distributors.
A quick review of the financial history here suggests that Gentex has a rather robust growth story. For example, over the past five years, revenue has grown at a CAGR of about 9% and net income has grown at a CAGR of about 13%. The fact that net income outstripped revenue suggests to me that the company is nicely scalable. At the same time, dividends per share have grown at a compound rate of about 7%. The growth in dividends per share is abetted by a share buyback program the company launched in FY2015. Since then, management has returned just over $1.2 billion to shareholders (~$394 million in dividends, the balance from buybacks).
Comparing the first nine months of the year to the same period last year shows that growth is being maintained. Specifically, revenue is up about 3.4% from this time last year, and net income is up a whopping 20%. In addition, the company elevated both dividends and stock buybacks, per the financials below. Finally, I appreciate the fact that Gentex is debt-free. The fact that it has an ironclad capital structure is another reason to invest, in my view.
(Source: Company filings)
I’ve said repeatedly, and no doubt tiresomely, that finding a company that’s growing its cash flows at a rapid rate is necessary, but not sufficient, to invest well. Fortunately or not, we access those future cash flows via the stock, which is sometimes a very imperfect proxy for the health of the underlying business. If the market has bid the stock to excessively optimistic levels, the marginal investor will suffer. For that reason, I must look at the stock as a thing distinct from the business. I’m looking for a stock that, rather than being priced for perfection, is priced for mediocrity. If the market feels that a given business is going to languish, inevitable surprises will tend to be pleasant ones.
One of the ways we can gauge whether the market is optimistic or pessimistic about a given business is the price-to-free cash flow ratio. As the graphic below shows, the price-to-free cash is currently at a multi-year low for Gentex.
While I don’t think history necessarily repeats, it may rhyme. The last time shares were this inexpensive on a price-to-free cash basis (circled in red above for your enjoyment and edification), they went on to rally nicely. In my view, this picture exemplifies the idea that the less you pay for a future stream of cash flows, the greater will be your return.
Modelling Future Returns
While the past is interesting, and is the only thing that we have the potential to know, investors are understandably more interested in the future, and for that reason, I must spill some virtual ink on coming up with a reasonable price target for the shares. When I perform a forecast, I engage in a ceteris paribus exercise, meaning that I hold all variables constant but one. When it comes to this stock, I’ll hold the yield constant, while growing the dividend. Over the past four years, the dividend has grown at a CAGR of about 7%. In order to be as conservative as possible, though, I’ll forecast dividend growth at half that rate over the next four years. The results are outlined below:
(Source: Author forecast)
When I impose a very limited growth assumption (i.e., half that current rate), I forecast a total return for the shares of about 24% and a CAGR of ~5.5% over the next four years. I think this is a reasonable return. I also like the fact that fully 40% of these forecasted returns come from dividends, which, as we’ve seen over the past few months, are a much more predictable source of returns than capital gains.
Appeal To Authority
It must be said that not all investors are created equal. Some are simply better at this than the rest of us. Some investors simply have emotional makeups that make them better at this, and some have access to teams of dedicated analysts. Another group of insiders who have an even more keen insight into the fortunes of a given business are, of course, insiders. These people understand the business far more than some Wall Street analyst ever will, and when they buy, it makes sense to at least stand up and take notice.
With that in mind, I’ll point out that over the past three months, insiders purchased 1,619 shares of the company, bringing this group's total ownership up to 179,071 shares. Perhaps the recent buying spree is a function of the fact that the shares are trading at multi-year lows. Whatever the reason, in my view, if the people who know this business better than anyone keep ~$3.6 million of their own capital in the company, I’m comfortable doing the same.
Risks To the Thesis
Given that Gentex relies so heavily on the automotive sector, challenges faced by that sector inevitably percolate down to the company. With that in mind, there is reason to suggest that automotive will actually remain relatively stable in 2019, although investors should note risks from tariffs and rising input costs.
In my view, though, these risks are already "baked into" the price. The market is obviously aware of these risks and is, in a sense, overreacting to them, in my view. Thus, the marginal investor is largely insulated from these risks, given that they're buying low.
In my view, Gentex is a "growth" company that is trading like a "value" company. The stock is at a multi-year discount, and the last time it was this inexpensive, it went on to do very well. My confidence is further abetted by the insider buying activity that we’ve seen recently. My dividend model suggests a return of about 5.5% for this company. I wouldn’t be surprised if this is a conservative forecast and Gentex surprises to the upside. I’m buying shares, and I recommend other investors do the same.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GNTX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.