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Five Undiscovered Small-Cap Gems

Skip large-caps and look at smaller stocks to find hidden gems. (photo credit: Getty)

Getty

Twenty-five Wall Street analysts cover International Business Machines  (IBM) and 22 follow Pfizer (PFE). If you invest in big, well-known stocks like these, it’s a challenge for you to see what others don’t.

Your odds of finding an undiscovered gem are higher, in my opinion, in the realm of small stocks. That’s why I’ve always been partial to them.

Mutual funds and pension funds often don’t pay the market’s small fry much attention. If these behemoths eventually pile in, the thundering herd can push up a stock’s price.

Here are five stocks that I think may be undiscovered gems.

From Clearwater, Florida, comes MarineMax (HZO), the largest U.S. recreational boat dealer. It sells a variety of brands, such as Boston Whaler, Sea Ray, Azimut Yachts and Hatteras. By reputation, it charges more than some other dealers but offers superior service.

As you might expect, hardly anyone was buying boats during the great recession. MarineMax posted big losses in 2008 and 2009, and another loss in 2011. Since then it has been profitable every year, and profits have accelerated lately.

A low-debt choice is Miller Industries (MLR), with debt only 7% of stockholders’ equity. Based in Ooltewah, Tennessee, Miller manufactures tow trucks and car carriers.

The company has been profitable in each of the past 15 years, even during the Great Recession. The shares have ramped up about 67% in the past three years, but remain reasonable at 11x earnings and 0.5x revenue.

As far as I can tell, Miller has no following on Wall street whatsoever. Some academic studies have suggested that a scanty analytical following is associated with higher returns–though I wouldn’t depend on that as a sole selection factor!

Profits at Home Bancorp (HBCP) of Lafayette, Louisiana, have improved lately. Last year it earned a 1.45% return on assets (above 1.0% is considered good) and a 10.9% return on stockholders’ equity (nothing special, but better than in the past).

Only three Wall Street analysts follow this little bank (there’s that analytical neglect again) and they all rate it a “hold,” which is about as much of a compliment as “nice personality.”

Meanwhile, the bank, which has some 39 branches in Louisiana and Mississippi, has quietly grown its revenue and book value (net worth per share) at a steady 8% pace for the past decade.

People love their pets. Pet medicine is therefore a growing niche, and selling it via the Internet is the specialty of PetMed Express (PETS).

There was a flap a year or two ago in which a short seller accused the company of selling opioids to humans, under the guise of selling them to pets. I am satisfied with PetMed’s response, which is that less than half of 1% of its sales are for opioids.

The company, based in Delray Beach, Florida, boasted a 34% return on stockholders’ equity last year, and is debt-free.

Ennis (EBF), formerly called Ennis Business Forms, is a mature business. Yet its earnings have grown at an 11% clip over the past five years, and 15% last year. People may be using fewer forms on paper but they still use plenty that are generated on a computer.

As befits a mature company, Ennis offers a substantial dividend yield, a bit over 4%. In a bull market that is in its 11th year, that’s comforting.

Track Record

I’ve written 25 columns on small stocks that I think are undiscovered gems. I have tabulated the results for 21 columns written from 2000 through 2018. Unfortunately, I can’t find full data for the ones I wrote in 1998 and 1999.

My picks have returned 15.4% in 12 months, on average. That beats the 6.7% average on the Standard & Poor’s 500 Index for the same periods, and also the 9.8% return on the Russell 2000, a small-stock index.

Seventeen of the 21 columns were profitable, 14 beat the S&P 500 and 13 beat the Russell 2000.

Bear in mind that my column recommendations are theoretical and don’t reflect actual trades, trading costs or taxes. Their results shouldn’t be confused with the performance of portfolios I manage for clients. And past performance doesn’t predict future results.

Performance of my selections from a year ago was hideous. Collectively, they lost 25.8%, while the S&P 500 returned 10.6% and the Russell 2000 returned 2.7%. I had big declines in Beasley Broadcast Group (BBGI), Ultra Clean Holdings (UCTT) and Fonar (FONR).

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Disclosure: I own shares in PetMed Express and Fonar personally and for clients.

John Dorfman is chairman of Dorfman Value Investments LLC and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at jdorfman@dorfmanvalue.com.

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