When evaluating small-cap stocks, individual investors would do well to emulate private-equity professionals.
Focusing on balance sheets and private-market valuations of small companies cuts through the noise sounded by volatile stock markets like today’s. After all, price isn’t always indicative of value. The difference between the two can mean big profits for discerning investors, says Mark Travis, chief executive officer of Intrepid Capital Funds.
Travis uses such a strategy to determine the price that a rational buyer, paying cash, would offer for a company. Many companies he follows are growing fast and generating a lot of cash, but retail investors know very little about them because they fly under Wall Street’s radar.
Travis says companies that generate cash consistently attract suitors, either larger companies in their industry or private-equity firms. If neither comes forward, Travis is happy knowing the investment will continue to grow as the company’s cash builds up.
Stable businesses with little debt tend to be winners, Travis says.
“That makes them durable when you go through some of the bumps we’ve been through in the last three to five years,” he says. “We’re not trying to front-run Steve Schwarzman at Blackstone (BX). We just happen to like the characteristics of cash generators.”
Three of the companies on Travis’s list are as follows:
- Tekelec (TKLC):
Travis’ Take: “This is an off-the-radar pick. It’s an example of a company that has a really beautiful balance sheet and a share price trading at a low multiple. This trades at 12 times earnings. There’s no debt and there’s $226 million in cash. Almost a quarter of the market cap is in cash. You’re able to buy it at a little over five times pretax cash flow. We think those shares are worth in the high teens.”
- Aaron’s (AAN)
Travis’ Take: “People don’t realize with the financial-regulation bill that credit won’t be more available; it’ll be less available. This company has 1,700 stores with about 1,000 of those franchised and about 700 corporately owned. At $16, it has a 12 multiple and a beautiful balance sheet. It has $54 million in debt but $85 million in cash, so they have net cash on their books. It’s a good business and could trade in the mid-20s.”
- Tidewater (TDW)
Travis’ Take: “They service offshore oil rigs, which certainly have gotten a lot of negative press. But they have a clean balance sheet, with $300 million in debt and cash of $122 million. Less than 10% of revenue comes from servicing rigs in the Gulf of Mexico. It trades at less than 10 times earnings and you get a dividend of 2.4%. We think the shares are probably worth $53 or $54.”