This Week’s Leading Small Cap Stocks - Homebuilders, Tobacco, and Technology Distributors
After what was literally one of the worst Januarys ever, the first week of February is offering considerably more encouragement … particularly from certain small cap groups. As we wind down the week, the small cap industries with the best returns include homebuilders, tobacco stocks, steel (and technically aluminum), semiconductors, and technology distributors. Some of those trends we believe have some longevity to them, and are therefore worth investor consideration. Some other pockets of small cap strength may just be deceptive rallies, and are best avoided. Let’s drill down into each of these groups to see which is which.
Homebuilders
If you caught our comments on the homebuilder rally earlier this week, then you already know our stance here - the 21.6% average gain in these stocks over the last five sessions just isn’t sustainable. The rally is strong, and may make for a good trade. However, the underpinnings here just don’t support any real long-term potential (or even short-term potential) for most of these stocks. We looked high and low for profitable companies - or even just reasonable hope for a profit in the foreseeable future. We just didn’t find it from the large caps or the small caps.
Tobacco
The S&P Small Cap Tobacco Index is up 17.9% this week, which is great. Better yet, the chart suggests there’s lots more room to recover. Even better is how the small caps in the index are actually justifying the rally … though there’s something of a catch in the regard.
The main ’small’ tobacco stocks are Lorillard Inc. (LO), Vector Group Ltd. (VGR), and Star Scientific Inc. (STSI). Technically though, Lorillard is a constituent of the S&P 500 - a large cap index. We’re not going to split hairs here, as Lorillard is still a small company with a market cap of ‘only’ $10 billion (which is still small even after the 2008 marketwide-implosion standards are applied). We just wanted to disclose that one of the key drivers of the recent strength from the small caps may not technically be defined as a small cap. In spirit, however, it is a small company. Vector and Star are both true small caps though.
More importantly, Lorillard’s and Vector’s charts are looking as bullish now as they have in months. Oh yeah - the fundamentals are sweet too. Lorillard’s net margin last quarter was 25%, and the twelve-month ROE is 83.9%. Vector’s results aren’t quite as impressive, but the dividend yield is a nice 11.0%. (Vector seems to be rising more on its forecast than on actual results, which is still a valid reason.)
So, this trend is one we believe in. It may be time to take a puff of small cap ’smokes’ stocks.
Steel/Aluminum
We’re not particularly impressed with this week’s 22.9% surge in small cap steel stocks, nor with the 22.8% pop in small cap aluminum stocks. We’ve seen similar moves from these steel names before, to no avail. And, aluminum’s bounce was likely more of a dead-cat bounce … they were crushed the week before.
Semiconductors
The 17.9% pop this week from small cap semiconductor stocks isn’t bad, but most of it came on Friday. And as with steel stocks, we’ve seen this before; none of the recent surges have followed through. We’ll keep an eye on it, but we don’t see any real longevity here.
Technology & Distributors
Technology and distributor stocks may be not only our favorite small cap group this week, but perhaps for the entire first quarter of 2009 (the distributors in particular).
Yes, this trend does seem to have longevity. It started slow, accelerated at a reasonable pace, yet is still nowhere near being overbought in the short run. And yes, the underlying fundamentals for the majority of these companies do indeed support the rally here.
Take Dolby Laboratories Inc. (DLB) for instance. Net margins came in at an amazing 29.7% last quarter, the ROE of 21.3% tops the industry average, yet the P/E (12 month) is only 17.3.
LDK Solar Company (LDK) is one of several solar panel makers in this group that also boasts some nice numbers. Net margins of 16.3% and a P/E of 3.7 are attractive, but not unusual for many of the small cap solar stocks in this group.
WMS Industries (WMS) is a small cap technology distributor - a niche segment that was shielded from the brunt of the recession, and now better off for it. The P/E of 14.2 and last quarter’s net margins of 13.3% aren’t anything to necessarily celebrate. However, what WMS and other distributors lack in pizazz they make up for with reliability.
Point being, we’re taking the S&P Small Cap Technology Distributor Index rally as a serious hint of what’s to come. It really could be one of the very best Q1 investment opportunities, if you can segregate the distributors from the rest of the technology group.
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Being a small cap/Micro Cap investor myself, I thought you should take a look the following 3 stocks. Of course, I won’t just give you a ticker, I thoroughly explain my choices with COMMONLY USED acccounting metrics, which the majority can digest. My investment criterias in the small cap arena are:
1- positive working cap
2- positive free cash flow
3- positive net earnings
4- recurring sales whenever possible
5- small float owned in majority by insiders
6- insider trading at buying level or higher
7- no lawsuits or none which can have material negative effect
8- trading below or very close to book value (when book value is applicable
9- trading under 10x times net earnings
10- growth prospect whenever possible
11- knowledgeable management in their field with reasonable salary structure
12- limited or reasonable goodwill/intangibles
13- liquidity is prefered but sometimes a sacrifice when bottom fishing
14- very little long term debt or very reasonable debt/equity ratio
15- a situation hovering around the breakeven or inflection point where revenues are just beginning to overcome the cost structure
16- high gross margin
So having laid out research criterias, here are 3 of my current holdings, with justifications based on the above criterias
1) NTG Clarity (NCI.v on the TSX Venture): current price 0.045$
In the current global economic crisis, growth regions are few and far in between. Contraction is evident in North America, Europe and Asia. In the Kingdom, as North American pressures increase to reduce dependence on foreign oil, the Saudis have no choice but to forge ahead on fronts other than energy. Money and technological overhaul are still flowing in that region, which provides business opportunities unlike anywhere else. NTG Clarity has recognized this niche and made palpable steps in that regards, as shown by the contract spur in fall 2008. The latest press release is yet another stride in a desirable direction for shareholders who have an appetite for bottom fishing opportunities.
With the current float size (24.6M out.), even at 20 cents, the market cap of this company would still be under 5M$, representing less than 1x annual sales.
Important metrics and commonly used valuation items
• Gross margin exceed >40%;
• Profitability has been proven year over year;
• Current backlog based on latest set of press releases is noticeable and seems sufficient to ensure profitability in 2009(from my calculations) even if they don’t secure any more work in 09, understanding we are only in February;
The latest announcements were:
-Sept 11: 3M$ USD contract
-Sept 10: 1.1M$ USD contract (4M Saudi Riyals)
-Sept 3: 400k USD one month contract (1.5M Saudi Riyals)
• The aforementioned have resulted in significant insider buying these past few months;
- since december 2008, the President has swallowed 419 000 shares;
- since september 2008, the Chairman has swallowed 470 000 shares;
• Sensitivity analysis: with 25.3M share outstanding, it’s easy to grasp that a mere 200k in net annual profits will translate into EPS +.01$/share, making the current share price very attractive;
• As of the last financial statement, working capital alone was +.06$/share(1.5M$), thus no value is given for the business and its proven past net earnings capability;
Having secured a joint venture with Al Mozoon (http://www.almozoon.com/aboutus.php) to accelerate Kingdom penetration, it will be interesting to see if any of the particulars involved in this JV take an equity position in NTG Clarity, or better yet, if thru their discussions/influence on Saudi Arabian Sheiks, they entice this family of riches with ideas on the same line of thoughts.
Here is just one passage from their website: “…AMT recognizes the benefits of partnering and recently become a 100% owned Saudi Company. Due to this AMT now has access to a wide pool of resources with proven ability in design, installations, testing, commissioning maintenance and manages all aspects of the projects.
AMT has ability to provide services throughout the national telecom coverage with a regional support across the Kingdom of Saudi Arabia. AMT is one of the largest ‘Specialist Telecom Engineering Contractors’ and pride our self as value added, integrated and turnkey solutions telecom services company of Saudi Arabia.”
2) Epic Data (EKD.v - trading on TSX Venture ) : current price 0.04$
Earnings per share
• Q4= +570k, EPS +.04$/share
• Q3= +451k, EPS +.03$/share
• Q2= -287k, EPS -.02$/share
• Q1= -343k, EPS -.03$/share
• 2008 profits +391k or EPS +.03$/share (includes 100k received for sale of Ticket Manager, a non-recurring event).
Other relevant items and metrics
• 1.2M$ cash (.09$/share)
• Working cap -560k (because of 1M$ deferred revenues)
• Gross margin of 51% on 11.2M$ of revenues)
• Free cash flow positive
• 12.9M shares outstanding
• Just announced over 1M$ contracts in january 2009
• Lowest option price is 10 cents
• Last insider trade at 28 cents in june 2008 Yes….you read correctly, Q4 and Q3 together total 7 cents per share EPS and the stock is trading at 3 cents today.
3) XDM.V (Xentel trading on TSX Venture) : current price 0.13$
XDM.v has declared +.04$/share profit for the first 9 months of 2008, and the stock is trading like if all events have been cancelled due to the market crash. However, it is comforting to know there is sufficient amount of public information, readily available, to understand just how much business Xentel has done in oct/nov/dec, and going forward into 2009. One just has to click on the following calendar and see how many events were held, and how many are planned.
http://www.xentelevents.com/xentools/xentelevents/www.xentools.com/xennet420dev/Events/siteCalendar/calendar.html
Safe to say the company remains busy in the market turmoil and trading at less than 3 times the 9 month net earnings.
• insiders are all over Xentel, look at the latest trading
Dec 31/08 Dec 24/08 Platz, Michael Paul Direct Ownership Common Shares Class A 10 - Acquisition in the public market 33,000 $0.065
Dec 22/08 Dec 22/08 McAleer, Francis Thomas Direct Ownership Common Shares Class A 10 - Acquisition in the public market 30,000 $0.070
Dec 22/08 Dec 18/08 Amyot, Bernard Direct Ownership Common Shares Class A 10 - Acquisition in the public market 100,000 $0.100
Dec 11/08 Dec 10/08 McAleer, Francis Thomas Indirect Ownership Common Shares Class A 10 - Acquisition in the public market 5,000 $0.100 Dec 11/08
Dec 09/08 McAleer, Francis Thomas Indirect Ownership Common Shares Class A 10 - Acquisition in the public market 45,000 $0.100
Nov 28/08 Nov 26/08 McAleer, Francis Thomas Control or Direction Common Shares Class A 10 - Acquisition in the public market 15,000 $0.100
Nov 28/08 Nov 26/08 McAleer, Francis Thomas Direct Ownership Common Shares Class A 10 - Acquisition in the public market 90,000 $0.100
Note: The above is simply my personal understanding and not to be construed as investment advice. I’m not a broker, promoter, director, manager or employee of the aforementioned companies, just a shareholder. Do your own due diligence.
Comment by QIS_Tara — February 12, 2009 @ 10:52 am