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Is Watsco (WSO) A Great Investment Choice?

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LRT Capital Management, an investment management firm, published its first-quarter 2021 investor letter – a copy of which can be downloaded here. A net return of +5.12%% was recorded by the LRT Economic Moat strategy for the Q1 of 2021, while the LRT Market Neutral strategy returned +2.4% for the same period. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.

LRT Capital Management, in its Q1 2021 investor letter, mentioned Watsco, Inc. (NYSE: WSO), and shared their insights on the company. Watsco, Inc. is a Coconut Grove, Miami, Florida-based HVAC company that currently has an $11.1 billion market capitalization. Since the beginning of the year, WSO delivered a 27.49% return, extending its 12-month gains to 63.48%. As of May 27, 2021, the stock closed at $288.82 per share.

Here is what LRT Capital Management has to say about Watsco, Inc. in its Q1 2021 investor letter:

"Watsco is a long time holding of our fund that recently made it into the top ten. The company distributes Heating Ventilation and Air Conditioning equipment (HVAC). The HVAC distribution business is approximately 80% replacement / 20% new construction. This is a great business due to the fragmented supplier base (seven major HVAC manufacturers) and fragmented buyers (thousands of HVAC contractors). This limits the bargaining power of both buyers and suppliers. Furthermore, while homeowners ultimately pay the bill, in most cases it is the contractor that makes the purchasing decision. Parts availability, speed of delivery and ease of installation play a major role in the purchasing decision with price being only a secondary consideration. Most HVAC equipment is bulky and difficult to ship – limiting competition from online players. Simply put, when your HVAC unit breaks on a hot summer weekend you don’t spend time shopping around for the lowest price – fixing the AC unit becomes a priority no matter the cost. The company’s earnings are also extremely predictable given that the majority of sales are tied to replacement demand which itself is a function of the installed base.

Watsco is the largest player in a very fragmented industry. The company earns mid-teens returns on invested capital and pays out the majority of earnings in the form of dividends. The company also expands through acquisitions over time, buying up smaller independent HVAC distributors. Most recently they have acquired Temperature Equipment, a Chicago based distributor. Watsco also has the most unique long-term compensation policy for senior executives we have ever come across in corporate America – all stock grants vest at retirement or after 10 years, whichever comes later. This makes managers extremely long-term focused, something we believe is a real benefit for a company that grows primarily through acquisitions.

Watsco last reported earnings on February 11th, beating both top (EPS +24% YoY) and bottom line estimates. The company also raised its dividend in conjunction with reporting earnings. Shares are up 18.85% year-to-date. We believe the shares are attractive at 37x trailing and 33x forward earnings given the extremely predictable earnings the company enjoys, recession proof nature of the product and long growth runway. GAAP earnings are understated due to the amortization of intangible assets related to prior acquisitions."

Biggest Logistics Companies in the World
Biggest Logistics Companies in the World

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Our calculations show that Watsco, Inc. (NYSE: WSO) does not belong in our list of the 30 Most Popular Stocks Among Hedge Funds. As of the end of the first quarter of 2021, Watsco, Inc. was in 22 hedge fund portfolios, compared to 24 funds in the fourth quarter of 2020. WSO delivered a 17.22% return in the past 3 months.

The top 10 stocks among hedge funds returned 231.2% between 2015 and 2020, and outperformed the S&P 500 Index ETFs by more than 126 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds’ poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Here you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

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Disclosure: None. This article is originally published at Insider Monkey.