Our 2006 CEO of the Year

A Minute to Learn, a Lifetime to Master
Fastenal makes lots of money--for itself and for shareholders--by doing something very simple: distributing the stuff that keeps industrial America running. The company started out 40 years ago distributing threaded fasteners, such as screws, nuts, and bolts, but has since branched out into selling just about anything that a machine shop, factory, or construction site could need, from approximately 2,000 locations across North America.

That may sound dull, but there's nothing boring about Fastenal's financial results. How many businesses do you know that have compounded earnings at almost 30% annually over the past 20 years without acquisitions or external capital, while generating returns on invested capital north of 20%? The company's share price has kept pace with its financials, also compounding at about 30% since Fastenal's 1987 initial public offering. It's tough to find a more impressive--or consistent--record of financial success over the past couple of decades.

Fastenal compiled this track record by building on a very simple insight. When running a factory or construction site, time really is money. So, customers are happy to pay a bit more for a bolt or screw if they get the right one and they get it fast, because industrial employees are getting paid by the hour even if the project is held up for lack of some special fastener or other supply item. By emphasizing service and selection, Fastenal makes money for shareholders by helping its customers make money--a recipe for success in any business.

Continuous Improvement
You might expect Fastenal to grow mainly by opening new stores, since the demand for fasteners and industrial supplies is not growing at a double-digit long-term rate. Certainly, opening new stores is a big part of the story, and the firm targets a midteen store count growth rate. But by taking market share from competitors and expanding its product offerings, Fastenal has managed to increase sales at an average annual rate of 9% at its mature stores--those open for more than five years. That's a phenomenal pace for older stores in any industry, let alone one as mature as industrial distribution.

One way that Fastenal achieves these kinds of results is by not resting on its laurels. A few years ago, just after Oberton took the helm from founder Bob Kierlin, the company undertook a store overhaul program that increased store traffic and sales growth without requiring a large investment in new head count--in fact, sales per employee jumped 30% in just a couple of years. And this overhaul was barely finished when Oberton initiated a second round of improvements, which included adding delivery vans, extending hours at high-potential stores, and pulling inventory from distribution centers to stores so customers have a larger selection.

Oberton has also invested in two other high-impact programs, centralizing accounts-receivable collection and bringing more of the company's trucking needs in-house. As with the store-level improvements, the results here have been impressive, with accounts receivable growing much more slowly than sales, and per-store delivery costs meaningfully reduced. As you might imagine, some of these initiatives have hurt the company's margins over the past few quarters--which may be why Wall Street has soured on Fastenal's shares a bit this year--but they're all smart long-term moves. After all, when your business has high returns on capital and excellent growth potential, the correct capital-allocation decision is to continuously reinvest for the long haul, regardless of the effect on quarterly results.

Shareholders Come First
Of course, strong financial performance is just part of what we look for when deciding on our CEO of the Year. We also need to see excellent corporate stewardship, and Fastenal is a role model in this area, as well. In fact, Fastenal is proof positive that a company can generate superior long-term wealth for shareholders without issuing a ridiculous number of options, without lard-filled executive compensation packages, and without a rock-star CEO who has a higher profile than the company itself.

For starters, Fastenal has superb financial disclosure and almost everything we like to see from a corporate governance perspective--no takeover defenses, related-party transactions, or anything of the sort. Compensation is very reasonable, bonuses clearly vary with the company's results, and the firm's directors and executives own about 17% of the shares outstanding. Option issuance is minimal--the firm's share count hasn't budged for two decades (except for stock splits)--and Fastenal's first tranche of options came from founder Bob Kierlin's personal holdings, rather than the creation of new shares. Oberton himself said in a 2003 interview that, "We have a fundamental belief that if they [investors] buy 1 percent of the company, that is what they should get."

It's tough to argue with that.