Rediscover Dirt Cheap Micro-Caps

 | May 21, 2013 | 1:00 PM EDT  | Comments
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A funny thing about a seemingly non-stop rising market is that Mr. Market tends to focus on the 50% of the equity population that probably accounts for 95% or more of the stock market.

That focus is rational. The majority of investment dollars is in the hands of pension funds, mutual funds, and hedge funds. Either by mandate or asset size restrictions, these groups have to focus in areas where they can put meaningful sums of money to work. Plus, the business of the stock market -- research reports, newsletters, and so forth -- has to focus on what sells, which often means widely-held stocks.

Such market mechanisms are a blessing in disguise for the majority of investors who aren't working with tens of millions of dollars. Micro-cap stocks tend to be neglected, even today. Revisiting some names, the opportunities look as compelling as ever.

General line retailer ALCO Stores (ALCS) is absurdly cheap stock for the patient investor. ALCO owns about 217 stores, averaging about 18,000- to 21,000-square feet, that sell everything under the sun. Formerly known as Duckwall, the company started out as a general dime store back in 1901 in Kansas.

When Sam Walton was building Wal-Mart, he visited many Duckwall stores as a source of ideas (perhaps ALCO should have been paying attention to Walton!). In any event, we know what became of Wal-Mart but ALCO is unique in that over 70% of it stores operate in small towns where Wal-Mart or Target would not remotely be able to operate.

With a market cap of $30 million, Wall Street isn't paying attention. How else do you explain a share price of $9.30 against tangible book value per share of $31? How else do you explain annual revenues of approximately $500 million? And the company is profitable -- it made $1.3 million in the last fiscal year.

But the future will likely improve. Management is incentivized by one principle metric, return on equity. So to earn a bonus, executives have to increase return on equity above 4%. At a 5% return on equity, ALCO is making $5 million a year -- not bad for a $30 million business. Put another way, Wal-Mart generates net margins of 3.6%. If ALCO can do half, or 1.8%, the company makes $9 million a year. Patience pays.

Ballantyne Strong (BTN) is just plain cheap. And there is a business that comes with it, too. The company is a supplier of digital theater equipment, a business that is currently taking a breather. Shares trade for $4.15, valuing the company at $58 million. Book value per share is $4.77, total cash per share is $3 and there is zero debt. Management is aggressively looking for a way to deploy the capital via an acquisition, regardless of whether it complements the existing line of business.

In the meantime, many large shareholders are taking Ballantyne management to task about the cash, and whether it should be paid out as a dividend or used to buy back stock.The big risk is that management does something dumb. This is something I've seen happen more than occasionally: management making a poor acquisition to keep busy.

So far, the management at BTN seems to be taking a disciplined approach, but one never knows.The upside is the cash protection, plus a catalyst that shareholders become more active with respect to the cash. But with how the balance sits now, BTN is an exciting bet.

If you are fortunate enough to have hundreds of millions of dollars at your disposal, you can't do anything with these names. But for everyone else -- the majority I would presume -- there are some exciting opportunities flying under the radar.

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