ALAN BROCHSTEIN LOOKS FOR SMALL-CAPS

With just a few weeks to go, it is looking possible smaller stocks could again underperform bigger ones in 2012, though not by as wide a margin as last year. After a long period of very strong performance, smaller stocks have been moving more in line with bigger ones over the past few years. From May 2000 until the end of 2006, small-caps, as measured by the Russell 2000, had a huge run, increasing in price by 65% while the S&P 500 was unchanged. Since then, the S&P 500 is unchanged, but the Russell 2000 has increased by 5%. What stands out to me is the performance since April 2011, as the S&P 500 has increased 4% but the Russell 2000 has declined by 5%.

Smaller stocks could potentially reassert their dominance as we begin 2013, so I am interested in finding some new ideas. When I am looking at smaller companies, I tend to look for many of the same things that I like to see in larger companies:

  • Reasonable or Cheap Valuation
  • Positive Price Momentum (or extreme negative momentum or oversold)
  • Strong Projected EPS Growth
  • Strong Balance Sheet
  • History of Strong Sales Growth

With this in mind, I am going to share a screen that is designed to uncover small companies showing all of the favorable attributes I cited above:

  • Universe:  Russell 2000
  • Market Cap:  >$500mm
  • Sales growth:  5yr > 10%, 1yr > 6%
  • Trailing PE < 24
  • Earnings Growth for 2013 > 10%
  • Net Debt to Capital < 10%
  • 3-month Price Return > S&P 500 (-4%)
  • YTD Price Return < 20%

Here is what we get:
 


Please keep in mind that these are not recommendations! As always, you should do your own investigation before purchasing any stock. I have highlighted a few things that stand out to me. First, three of the four companies have more cash than debt (highlighted in green). Also, while these companies have historical sales growth and projected near-term future earnings growth well in excess of the S&P 500, the valuations are for the most part lower on a PE basis (shaded in green except for the one stock that’s more expensive in red). Finally, relative to their historical valuations over the past five years (last column), all of these stocks trade at steep discounts.

Emergent Biosolutions (EBS) is a specialty pharmaceutical company. Their CFO just left for another opportunity, which leaves me a little cautious. The company laid out its growth plans for the next few years in early November, with a goal of achieving greater than 15% net income growth through 2015 as it reaches $500mm in sales and expands its offerings to at least three products. Currently, almost all of their sales, which are projected by the company to reach $280-300mm this year, are from BioThrax, which is an anthrax vaccine.

Enstar Group (ESGR) invests in reinsurance companies in run-off mode, trading at a modest premium to its book value (1.2X). The company has de-leveraged its balance sheet this year (reduced debt) while also executing two large acquisitions. Insiders own about 23% of the company.

Hub Group (HUBG) has two businesses, including Mode, which it acquired in 2011 and which offers freight transportation services on an agent basis, and Hub, which has a comprehensive intermodal, truck brokerage and logistics business in the U.S. and Mexico. Hub is substantially larger. The company indicates that it’s the largest intermodal marketing company in the U.S. (shipping freight in containers and trailers over long distances using trucks and trains). I have to admit that I don’t have much more background information on this one. They have been in business for 41 years. The stock trades at 15.3X 2013 estimates.

The last one is one with which you may be familiar, as Coinstar (CSTR) operates the ubiquitous Redbox network of DVD rental kiosks. The company has several other new markets it is entering with its technology, including premium hot coffee kiosks. It finally announced an internet strategy too, partnering with Verizon to deliver streaming videos for $6 per month (and $8 for a plan with up to four physical rentals). The valuation here, at 11PE on a forward basis, seems too low. The company thinks so too – it entered into an agreement to buy $75mm of its own stock in early November.

With the recent performance, or under-performance, of small caps, it could be prudent to look at these smaller companies. Hopefully I have given you a few ideas about how to investigate smaller stocks. There is screening software available to investors, often free, that can help in the process. I encourage you to learn about the characteristics that are important to you and to use them to narrow down what can be an overwhelming universe of stocks. Hopefully, you can uncover a gem! Remember, screening is a starting point as part of a more thorough investment process.

Regards,

Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

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