Don't Write Off Micro-Caps

 | Aug 05, 2013 | 3:00 PM EDT  | Comments
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From time to time, I've been a big advocate of investing in micro-cap stocks, or businesses that I define as having a market capitalization of $250 million or less. I often like to go real small and look at businesses under the radar of Mr. Market and Wall Street -- those with market caps under $100 million. 

Of course, this area of investing can either be quite fertile or quite explosive due to greater price inefficiency and higher vulnerability to both macroeconomic and microeconomic factors. But, rather than rehash those factors, in today's heated market I'd rather focus on the value of a high-quality business that is being ignored by 95% of the market due merely to its size. I'll look at a couple of names that have graced the pages of my column before -- one whose time has passed and another that simply needs more time for its valuation to come to fruition. 

Back in October 2012, I wrote a Long Shot column on small-town retailer, Alco Stores (ALCS). Alco's appeal is extraordinarily simple: It's a general retailer that generates nearly $500 million in sales per year and operates primarily in that most people have never heard of. Such towns are not places where Wal-Mart (WMT) or Target (TGT) have any interest in setting up shop, but those towns still need somewhere to buy batteries, coolers, televisions, socks and so on. Alco isn't new to the business, either. In fact, 50 years ago, a guy by the name of Sam Walton used to visit often to get ideas for his budding retail operations. 

Back in October, Alco shares were trading for $7, giving the company a market cap of $26 million, Book value per share was $24, and sales per share were $140. Two weeks ago, a private investment group came in and offered to buy the company for $14 a share. The stock now trades for $14.15, making for a tidy 100% return in less than 10 months. I would argue that this upside came from the shares' inefficient pricing, as is typical of micro-caps. Larger well-known retailers, even when they are temporarily struggling, rarely trade for 20% to 25% of book value or 5% of sales. 

Another interesting name, and one that has gone nowhere for a while now, is Ballantyne Strong (BTN). The company makes digital theatre equipment and specialty lighting systems -- and, after record profits due to investments by movie theatres, the company's earnings have pulled back. In the meantime, shares are trading for $4.20, or a market cap of $59 million. The company has no debt, and it sits on $3 per share in cash. Book value per share is $4.80.

The company is due to report second-quarter results Aug. 8. Provided that the company hasn't squandered away the cash and that operations look stable, Ballantyne stock should really be trading closer to $6 vs. where it is now. 

But the fact that I was correct with Alco doesn't mean we'll see the same outcome in Ballantyne. The big-picture takeaway is that micro-caps can often be so inefficiently priced that only catalyst you need is time. Names like Alco and Ballantyne are high-quality names with real businesses that have operated for decades. Under such circumstances, size really doesn't matter. Instead, you simply need the willingness to be patient while the price to value gap still remains.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider ALCS and BTN to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

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