One thing I’m becoming more and more convinced of over time is that the opportunity for individual investors to generate market-beating returns is to go into the markets and assets that Wall Street either can’t or doesn’t want to go. Not because I think that Wall Street is consistently wrong. Instead, I think the probability of finding a mispriced asset is more likely found in parts of the market with fewer people looking at it than the parts of the market with all of the eyeballs, writes Tyler Crowe, author of Misfit Alpha.
Fortunately, for individual investors, the universe of stocks Wall Street pays attention to is getting smaller. According to a recent paper in Accounting Research Journal, firm-specific analyst coverage of securities has declined 17.8% globally.
This isn’t too surprising. With more and more money flowing into passive index products, there is less appetite for coverage of companies. Those remaining analysts tend to huddle around the topics investors want to know about. It’s much easier to feed someone something they want than to serve an unfamiliar dish.
Small-cap companies can be a place where more of these mispriced assets fall through the cracks. For many reasons, most analysts and financial media outlets ignore this part of the market. The most significant reason is that it lacks engagement and is less profitable.
Even though there are opportunities, they can be harder to find. More than 7,000 publicly listed companies have market caps of less than $2 billion. And let’s face it, a lot of them are awful investments.
A couple of months ago, I created a market screen using Koyfin for small-cap companies that, I think, would represent a good starting point for digging into these less-covered companies. Here are the criteria:
- Trading region of primary security: USA & Canada
- Market capitalization: Between $1 million and $2 billion
- Return on total capital over the past 12 months (TTM): Greater than 15%
- Earnings before interest and taxes margin (TTM): Greater than 10%
- Price to Free cash flow: Less than 15 times
- Price to book value: Less than 2.5 times
In June, the screen spit out 79 companies, most of which were highly cyclical oil and gas companies. I thought it would be an interesting exercise to see how much this changed in just a short time. As of this writing, this same market screen only produced 58 companies with 15 new ones. Only eight “graduated” from the list (market caps larger than $2 billion or their valuations too high). The rest saw their profitability decline enough to get booted off the list.
You can find the complete list by clicking here. This market screen is ordered by market capitalization. The companies highlighted in green are the ones that weren’t found in the same screen back in June.
I think there are some exciting companies worth exploring in this list. Let’s use our collective brainpower to investigate some of these companies further.
