Published December 27, 2013
It has been a great year for investors. Stock indices are up close to 30%, with many individual names up even more. As we get ready to flip the calendars to 2014, the question becomes, what do you do for an encore?
One answer may be to look at some small-capitalization stocks that do not have a lot of coverage from brokerage firms or are not widely owned by institutions. This year’s rally has been largely liquidity driven, and the money does not flow to these neglected names as easily. Here are three under-covered names that could be ready to outperform in 2014.
Fortegra Financial (FRF) provides insurance services, primarily payment protection plans, to financial services companies and other institutions. It is a small company but hardly a newcomer, having been in this business for more than 30 years. FRF takes little underwriting risks, and instead earns a fee from taking on the extensive administrative and regulatory costs of operating an insurance company for its clients.
Earnings have been disappointing in 2013 as the company digested two acquisitions, but will be helped by continued cost-cutting efforts and revamped marketing programs. Very encouraging was the recent sale of the company’s insurance brokerage segment for $83.5 million, yielding a solid price of 10X EV/EBITDA. The company will be able to use the proceeds to pay off the debt incurred from the acquisitions, which will free management to step up the pace of share buybacks going forward.
EPS should be relatively flat this year at $0.83 a share versus $0.82 a share next year, and could fall back around to $0.78 a share next year to the sale of the insurance brokerage unit. However, this estimate does not take into account the use of the capital raised in the transaction. Beyond next year, FRF seems poised for steady growth and strong cash generation. At around 10X 2014 EPS estimates, the stock is a solid value. Keep in mind that the company is 63% owned by private equity firm Summit Partners, who wants to see value maximized beyond the $11.50 December 2010 IPO price.
Computer Services Inc. (CSVI) trades at an average of just 8,000 shares each day, so it moves around, but it’s a solid company with a good growth record. The company provides transaction processing services for banks, and recently enjoyed its 37th consecutive quarter of revenue growth. That is very impressive when you consider that streak started before the financial crisis. EPS has grown from $1.36 a share in the February 2009 fiscal year to $1.76 a share in February 2013.
Through the first six months of fiscal 2014, CSVI grew revenues 9.5% to $108.5 million while EPS increased to $0.86 a share from $0.81 a share. Operating margins have narrowed as management expanded their salesforce as part of a strategic growth initiative, but this program should drive strong results over the long term. CSVI still should be able to earn $1.86 per share in the current fiscal year, and at less than 18X this estimate, the company sells at a considerable discount to a larger rival, Jack Henry & Associates (JKHY), which sells at 25.5X forward estimates. JKHY has made several acquisitions in the past, and I feel they could be interested in CSVI at some point. CSVI may require some patience, but is a solid, growing company selling at a discount to its peers, and is a neglected name that could attract attention as investors search for new opportunities.
Intervest Bancshares Corp (IBCA) is a lender to multifamily and commercial properties in New York City and Pinellas County, FL, and specializes in lending in less developed areas. IBCA has no sell-side coverage, which is one of the reasons it is one of the few banks that sells at a discount to its tangible book value of $8.77 per share. Earnings are also being limited right now by the Fed’s zero interest rate policy, but net interest margins have been showing some signs of stabilizing at around 2.5%, and should improve over time as interest rates rise from depressed levels.
In addition, loans outstanding increased sequentially last quarter, and improving economic activity should drive further gains in the loan book. IBCA’s credit profile is good, as it only lends to income-producing properties, and loans are generally less than 70% of total property value. With a tier-one common ratio of 14.87%, IBCA is well-capitalized and easily exceeds regulatory requirements. I believe the company can earn $0.55 a share in 2014, with significant earnings upside once the Fed’s zero-rate policy ends. Meanwhile, I believe investors will turn to the stock as tangible book value continues to grow. I look for IBCA to snap back in advance of any significant increase in earnings.
Hilary Kramer is the editor-in-chief of the subscription newsletters Game Changers, Breakout Stocks Under $10, High Octane Trader, Absolute Capital Return Portfolio and Inner Circle. Formerly, Hilary was the CIO of a $5 billion global private equity fund. She has an MBA from the Wharton School at the University of Pennsylvania and began her Wall Street career as an analyst at Morgan Stanley. Hilary is the author of The Little Book of Big Profits from Small Stocks (Wiley) and Ahead of the Curve: Nine Simple Ways to Create Wealth by Spotting Stock Trends (Free Press).