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Could This Steady Small-Cap Stock Be Buffett's Next Target?

You can have your $100,000 electric cars or $8 organic burritos...

For my part, "boring" is exciting.

Judging by his portfolio, Warren Buffett would probably agree.

Look at some of the top holdings of his Berkshire Hathaway (NYSE: BRK-B ) , such as Procter & Gamble (NYSE: PG ) , Coca-Cola (NYSE: KO ) or Wells Fargo (NYSE: WFC ) . Soap, soda and banking... hardly cutting-edge.

Buffett's portfolio of smaller companies that he's purchased is also similarly mundane. The Oracle of Omaha likes businesses that are simple to understand, like See's Candy or Dairy Queen, that are well run and produce consistent results.

When I was looking for a story idea to pitch to my editors here at StreetAuthority, I went back to an obscure stock that I look at from time to time: Oil-Dri Corporation of America (NYSE: ODC ) . As I was doing my research, Oil-Dri struck me as a company Berkshire might like to gobble up.

So what does Oil-Dri do? Innovative waterless fracking or maybe some kind of specialized environmental cleanup? Not exactly. Oil-Dri is the world's largest manufacturer of cat litter.

Oil-Dri makes cat litter under the Johnny Cat and Cat's Pride brands as well as private-label brands. The company also produces sorbent materials for industrial, agricultural and automotive applications. It's not the sexiest business out there -- unless you dig a consistent stock.

After delivering an average annual return of 44% over the past five years, ODC has cooled off a bit from its all-time high. However, the underlying fundamentals remain compelling.

Over the past five years, earnings per share ( EPS ) and dividends have grown at an average annual rate of 11% and 7.6%, respectively. The dividend payout ratio -- the amount of cash from retained earnings the company is paying to shareholders -- sits at a comfortable 35%. (I don't like to see a payout ratio higher than 60%, unless it's coming from a REIT (real estate investment trust) or an MLP (master limited partnership).)

Oil-Dri's payout ratio means it's doing a good job of compensating its shareholders while reinvesting in its business. This year, Oil-Dri is on track for $6.8 million in capital expenditures, up 35% from last year. In addition, the company's long-term debt amounts to just 17% of its market capitalization.

Oil Dri is also focused on international growth, especially in Asia. The company's animal health subsidiary, Amlan International, recently hired a sales and technical support team that will be based in Vietnam and be tasked with driving market penetration for the company's livestock feed additives across the entire Asia-Pacific region.

Between July 2013 and April of this year, insider buys have outnumbered insider sales by a ratio of 5 to 1. This is significant, especially for a tiny company like Oil-Dri, which, with a market cap of just $223 million, is almost more of a micro-cap stock than small-cap. The fact that management has stepped up to the plate in support of their efforts speaks volumes... or they might think something's coming down the pike. But what?

In April, the Oil-Dri board of directors hired Mark Lewry as chief operating officer. Prior to coming to Oil-Dri, Lewry served as group president for five business units of the Marmon Group, a Berkshire Hathaway company. What's to keep his former boss from taking a look at a simple, solid, consistent business that would fold nicely into the portfolio?

Risks to Consider: The biggest risk with ODC is liquidity. A small market cap usually means thin trading volumes, and fewer than 10,000 shares of ODC trade hands a day, on average. The best defense is to use limit orders. Also, due to its small size, the company is undercovered by Wall Street analysts, which makes forward guidance difficult to get one's arms around.

Action to Take --> ODC trades near $32 with a 2.3% dividend yield and a trailing price-to-earnings (P/E) ratio of 15.2. Based on steady EPS growth of 11%, a 12- to 18-month price target near ODC's all-time high of $40 appears attainable. With the dividend factored in, that's a potential total return of 25%. Furthermore, a buyout premium of 30% to 40% to current prices (equaling $42 to $5 a share) for a company this dependable might be worth it to Buffett.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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