Meet the Little-Known Serial Acquirer That Has Rocketed Past the S&P 500's Returns Since 2010

One of my favorite "stocked ponds" to fish in when I'm looking for new investments is niche-leading businesses that fill a unique void in the world. If managed well, stocks with this trait often deliver long-term outperformance by dominating their smaller, less-focused-upon industries.

One company that fits this description is Federal Signal (NYSE: FSS), a specialty vehicle and public safety equipment manufacturer. Rising 1,460% since 2010 -- more than double the total returns of the S&P 500 -- Federal Signal is already a multibagger, but its future could prove to be even brighter.

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Here are the four key reasons I believe Federal Signal is a brilliant, little-known stock worth buying today and holding for decades.

1. Federal Signal dominates its industry verticals

Federal Signal operates through two business segments: Environmental Solutions Group (ESG) and Safety and Security Systems Group (SSG), which account for 83% and 17% of total revenue, respectively.

ESG sales come from manufacturing vacuum trucks (safe digging), street sweepers, dump truck bodies and trailers, industrial cleaning equipment, maintenance vehicles, metal extraction support, road marking vehicles, and aftermarket services. SSG revenue derives from public safety equipment (police car lights, for example), industrial signaling equipment, and warning systems.

Federal Signal holds a No. 1 or No. 2 market share across each of the niches listed above. However, in addition to its leadership in each vertical, the company benefits from diversification across its operations, thanks to the amalgamation of industries it serves.

For example, Federal Signal sells products powered by long-term megatrends like vacuum trucks, which are becoming ever more necessary due to the rise of safe digging. It also sells metal extraction equipment, which will support the shift to electric vehicles. At the same time, though, the company's steady Eddie verticals, such as road markers, aftermarket parts, and safety equipment, will remain necessary regardless of the macroeconomic environment.

With its customer base spread across essential government, industrial, utility, and oil and gas end markets, Federal Signal is a well-diversified powerhouse that remains under the radar.

2. It is turning into a successful serial acquirer

Though Federal Signal's leadership alone makes it an intriguing investment, its success with mergers and acquisitions (M&A) is what really sets it apart. Since 2016, the company has made 13 acquisitions. These purchases either built out its dominance in a niche or created a leading position in a new vertical.

Federal Signal's recent acquisition of HOG Technologies for $92.5 million is a perfect example of this strategy. By paying just over 1 times sales for HOG, the company added to its array of road marking, line removal, and water blasting equipment at a reasonably cheap price. This notion will be especially true if the company sees any synergies from the acquisition like it historically has.

However, in addition to complementing its existing road-marking operations, the acquisition expanded Federal Signal's reach internationally, all while introducing it to the airport end market.

Ultimately, this isn't a splashy purchase, nor are most of the company's acquisitions. However, Federal Signal's growing prowess as a serial acquirer makes it quite adept at maintaining and expanding its leadership positioning in an incremental fashion.

Best yet for investors, Federal Signal has maintained an average return on invested capital (ROIC) of 12% over the last decade. Since this ROIC has historically been higher than the company's weighted average cost of capital, it is fair to say that management is excellent at generating new profits from the debt and equity it uses to fund its M&A.

3. Improving margins and a dividend increase

Thanks to management's focus on acquiring companies that could offer a higher-margin profile after they integrate into Federal Signal, its EBITDA (earnings before interest, taxes, depreciation, and amortization) margins have steadily improved over time.

FSS EBITDA Margin (TTM) data by YCharts

To view it from another perspective, consider how much Federal Signal's EBITDA and free cash flow (FCF) figures have grown compared to sales since 2010.

FSS Revenue, EBITDA, FCF (TTM) data by YCharts

Powered by this ballooning profitability and cash generation, the company creates ample funding for its M&A ambitions. However, despite typically spending roughly 50% of its cash from operations on new acquisitions, Federal Signal raised its dividend by 17% this year after adjusted earnings per share (EPS) rose 29%.

While the company has historically prioritized increased spending on M&A over making substantial dividend payment increases, this recent boost nonetheless highlights the potential for dividend growth available with Federal Signal.

4. Premium traits at a sub-market valuation

Despite growing sales and EPS by 9% and 13% over the last decade, Federal Signal trades at a reasonable 23 times earnings. This price-to-earnings ratio sits well below the S&P 500's average of 29, despite the company's superior growth rates.

Considering Federal Signal's promising traits as a niche-leading serial acquirer with improving margins, I'll happily scoop up shares of this little-known stock as it looks poised to extend its market-beating run.

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Josh Kohn-Lindquist has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.