2 Picks: A Lock and a Golden Opportunity

08/08/2011 9:30 am EST

Focus: STOCKS

Marc Gerstein

Editor, Forbes Low-Priced Stock Report

These two low-priced stocks are ready for growth in the coming months and years, writes Marc Gerstein of the Forbes Low-Priced Stock Report.

Why bother with low-priced stocks at all? Answer: Because principles of scale apply on the upside.

If sales at our prototypical S&P 500 company rise 20%, operating profit would be rise 37.8%. But a 20% sales gain for a prototypical small company would produce a 49.2% gain in operating profit.

If we were to assume a 30% sales gain for the small company, given the lesser degree of diversity that usually exists among this group, we’d be looking at a 73.8% gain in operating profit. So we’d naturally expect the small stock to rally more vigorously.

But there’s more: We can add in the fact that smaller firms have more room to grow than do larger companies (even beyond a single-business focus). Now, we have return potential that may be powerful enough to justify the volatility.

Locking up is not as simple as it used to be. Traditionally, you’d buy a set of locks, each of which came with a set of easily replicable keys, and keep using them until you lost all the keys, moved out of the property, or the lock became somehow jammed.

Security is much more sophisticated today, giving NAPCO Security Technologies (NSSC) much more interesting growth opportunities than it has had at any time since its founding in 1969.

The company organizes its activities in terms of three areas each of which it can now address (enhanced by the mid-2008 purchase of Marks USA): door-locking technologies; access control; and monitoring for protection against fire and/or intrusion. Each area has evolved since the good old days.

For many, door locking still involves a hardware-store lock-and-key set. But increasingly, this is coming to mean locks activated by push-button codes, ID card readers, or even fingerprint readers.

Moreover, the newest iteration of this sort of protocol (i.e. Alarm Lock Trilogy Networx) enables standalone locking devices to communicate wirelessly over any sized network, allowing for rapid and remote deployment of global lock/unlock, thus avoiding the need for lots of wiring, which is important since traditionally-used telephone lines are diminishing in favor of modern alternatives.

Even when it comes to basic lock-and-key, NSSC can get quite rugged, as is often needed for commercial, industrial or government installations (including the White House and US Senate building).

Traditionally, NSSC has been slow-growing and modestly profitable, with returns on equity at low-single digit levels. By the mid-2000s, returns increased, but late in the decade, this R&D-intense company (usually 7% to 8% of sales) fell into the red thanks to the weak economy and operational restructurings.

It now appears to be returning to the black, and about to embark on an unprecedented growth track, as it combines, for the first time, its modern business profile with a good economy—prompting spending for new installations and retrofits of older spaces.

This does not appear to be reflected in the stock’s mundane valuation metrics. NAPCO Security Systems is a buy.

NEXT: A Golden Opportunity

|pagebreak|

A Golden Opportunity
Gold and low-priced stocks are often seen as compatible, given that both tend to be sought with the idea of achieving home-run potential beyond what one would expect from garden-variety stocks.

Adding to the allure of gold is the notion it can be used to hedge against the sort of financial and monetary concerns that could cause considerable angst for the very small companies in which we usually invest.

Claude Resources (CGR), a Canadian mining company, is a way to achieve gold exposure in the context of a low-priced stock portfolio.

Today, ETFs like SPDR Gold Trust (GLD) provide exposure to bullion, sparing investors the need to fret over the intricacies of futures, or the need to take delivery of and store the metal.

So a decision to own shares of a mining company must now be justified based on aspects of the mining business as practiced by the particular company. Generally, this relates to a company’s ability to boost volume while maintaining production costs and finances.

Claude seems capable of delivering the volume angle through its three south-central Canada mining interests. The main producing property, Seabee, had more or less been producing 45,000 ounces of gold per year.

Exploration at a mine on the property known as Santoy 8 has been fruitful, with the new facility entering commercial production and likely to drive Seabee’s overall production to 54,000 to 58,000 ounces in 2011. Costs per ounce have lately been running in the mid-to-low-$900s, but are likely to fall as new production will involve higher-quality ore.

Two other properties, Madsen and Amisk, are not yet commercial but work performed to date indicates considerable potential.

“Resources” (defined as a concentration of mineral material in such form and amount that economic extraction of a commodity from the concentration is currently or potentially feasible) on March 31 stood at around 660,000 ounces from Seabee…but when Madsen and Amisk are added in, the total shot up to 3,460,000 ounces.

The company maintains that ultimately, each of its three properties has the potential to produce 100,000 ounces per year, but for now, the annual production target through 2015 is limited to about 70,000 ounces and assumes Seabee alone.

It seems likely that new production can more than offset the impact of a larger share base. At this stage of the cycle—where gold has come far enough to even make many bulls wonder if it needs a breather—volume-oriented Claude Resources is a speculative buy.

Subscribe to the Forbes Low-Priced Stock Report here…

Related Reading:

Related Articles on STOCKS