Why This Small Cap Automotive Stock Will Keep Growing

It is official - the Russell 2000 is now trading in uncharted territory.

After Wednesday's historic press conference by Federal Reserve chairman Ben Bernanke, Wall Street pushed the Russell 2000 to its highest level on record. The Russell has climbed over 150 percent since March 2009 and is currently 9.9% higher year-to-date.

In last week issue titled, "Have Small Caps Peaked?" I suggested that investors should begin taking a more defensive position and consider reducing broad exposure to small caps due to their record prices and rich valuations.

Simply put, small caps have never been this expensive.

A Stock Picker's Market

With the valuation of the Russell 2000 so high, now is not the time to buy a small cap index fund such as the iShares Russell 2000 (NYSE: IWM). Rather, now is the time to perform thorough and extensive research to find stocks that offer attractive growth and trade at decent valuations and have been overlooked by other investors and analysts.

I have several on my watchlist that I will be relaying to you over the next few weeks. Today I'll tell you about a small cap gem that think will act as a great defensive growth stock in any stock market.

The company is automotive replacement parts supplier, Dorman Products (Nasdaq: DORM).

 

According to the Wall Street Journal, Japanese auto parts suppliers are having a difficult time meeting the demand needs of leading Japanese car makers Toyota and Honda. Moreover, the WSJ recently reported that the catastrophe in Japan is now starting to affect the production of North American car manufacturers. If the slowdown continues U.S. parts suppliers could feel the pain.

But Pennsylvania-based Dorman will not suffer the same fate and its business has never been better.

Dorman has positioned itself well within the auto parts supplier industry, using its innovation to churn out products at a record pace. After 10 years of sustained and accelerated revenue growth the company released a record number of new products in 2010, which I believe will help to fuel the company's long-term growth trend. It was the perfect storm because as the economy was rebounding Dorman was simultaneously ramping up their production.

The boost in new products was directly reflected in the company's first quarter earnings.

The company beat estimates as revenue grew 26 percent in Q4 to $124.5 million while full-year sales were up 23.4 percent to $481.1 million.

In terms of the bottom line, its first quarter earnings per share grew 56% to 69 cents, while full-year earnings for 2010 jumped 74% to $2.59. CEO Steven Berman attributes the company's success to the new product development efforts and said that "revenues from products introduced in the last two years topped 20% for the quarter". He expects to see the same in 2011. Analysts' EPS estimate for 2011 is $2.94.

The push for new products also solidified a competitive advantage for the company. According to Dorman's CFO, the company is able to use its innovation to get a two year window of no competition on its new parts. Furthermore, it has no competitors in many of its products lines.

Over the long-term the company has displayed consistent and stable growth over the past decade. Earnings trends show that they are growing solidly year over year. Its revenues have increased in nine consecutive years which is praiseworthy considering the sire economic situation that occurred back in 2007. Very few companies can make this claim.

Given the sustained and accelerated growth over the past 10 years and the competitive advantage created by the surge in new products during 2010. I think shares are at least 15-20 percent undervalued. In my opinion the growth in 2010 was only the beginning of what will be an extended run for Dorman.