Small Caps: No Respect

02/24/2006 12:00 am EST


Richard Moroney

Editor, Dow Theory Forecasts

"On Wall Street many small stocks are still treated like Rodney Dangerfield—they get no respect," notes Richard Moroney. But the editor of Upside argues that the greatest "upside" can come when these under-followed issues start gaining attention.

"Historically, buying stocks with relatively little analyst coverage has been a winning strategy. Also effective, according to researchers, is buying stocks for which the number of covering analysts has increased recently. A recent Bear, Stearns study combined these strategies by selecting all S&P 1500 stocks for which analyst coverage had increased in the previous quarter. It then divided those stocks into quartiles based on the number of covering analysts.

"Assuming quarterly rebalancing, the quartile with the least number of analysts returned 26.1% annually from 1995 through 2005, vs. 13.2% for the quartile with the most coverage. Looking to leverage this research, we screened our universe of small-cap stocks to isolate thinly-followed stocks that have seen a recent increase in analyst coverage. The three stocks below all earn our highest 'best buy' rating.

"CompuCredit (CCRT NASDAQ), a direct marketer of credit cards to higher-risk consumers, is capitalizing on strong demand for its credit cards and improved marketing initiatives. The company has diversified its asset mix and operations in recent years, including the issuance of a stored-value card and the marketing and servicing of micro-loans. The April 2005 acquisition of Wells Fargo’s subprime auto-lending business provided further diversification. Three analysts provide a rating for the shares, up from a single analyst at the end of September. CompuCredit’s p/e ratio is 10.5 based on expected earnings for the next four quarters—a 20% discount to its five-year average forward p/e ratio.

"December-quarter per-share earnings at Intervest Bancshares (IBCA NASDAQ) rose 54%, while total assets were $1.71 billion, up nearly 30% from a year earlier. For full-year 2005, per-share earnings increased 44% to $2.47. Per-share book value now stands at $17.41; over the last three years, per-share book value has increased at an impressive 15% annualized rate. Consensus estimates project per-share-profit growth of 13% for 2006 and 11% in 2007. Despite its strong growth outlook, only three analysts cover the stock, up from two at the end of September. Moreover, the shares seem reasonably valued at ten times expected year-ahead profits of $2.79 per share. Intervest trades at 1.7 times its per-share book value—a 13% discount to the average small-company bank stock.

"Steiner Leisure (STNR NASDAQ) a leading provider of spa services, has attracted Wall Street’s attention with impressive operating results and share-price action. Four analysts now rate the stock, up from two at the end of September. The company, with spas in 120 cruise ships and 56 land-based resorts, is benefiting from solid cruise-industry fundamentals and favorable trends in personal health. Steiner has agreed to acquire the Utah College of Massage Therapy for $28 million in cash. In 2004, the school had seven campuses in Arizona, Colorado, Nevada, and Utah. With the new locations, Steiner will serve some 3,000 students. Full-year 2005 per-share earnings should be $2.18. For 2006, the consensus is $2.42."

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