There's Still Value in Small-Caps

 | Aug 05, 2014 | 5:00 PM EDT
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As a group, small-caps have been a big home run for the past several years. On a relative basis, small-caps as a group have a higher valuation than their bigger cousins.

When the media refers to stocks as being fairly valued today or describing the stock market in any other way, the underlying reference is to the S&P 500, which is an index dominated by the biggest publicly traded companies. The top 10 members of the S&P 500, with Apple (AAPL) and Exxon Mobil (XOM) topping the list, have an aggregate market cap of nearly $3 trillion dollars.

The Russell 2000, consisting of 2,000 of the smallest securities based on market capitalization, has an average market cap of $1.8 billion, or less than $4 trillion combined. So, when the media also says that small-caps are becoming overvalued,  that statement is in reference to an overall index like the Russell 2000 and not indicative of all small-caps.

That's why I still don't rule out small-caps even today. I may have to look a little harder, but I still find names like Orion Energy Systems (OESX), a designer and manufacturer of lighting systems. OESX is focusing on LED lighting as a vehicle for growth and this is a business that at the bottom of the cycle today. The earnings release yesterday had negative short-term results, but if you read it more closely you can see that OESX is focusing its business on the long-term cycle upswing as the installed base of LED lighting grows.

I'm also looking at Atlas Financial Holdings (AFH), a $137 million underwriter of commercial auto insurance. Atlas has a niche in insuring taxi cabs, business automobiles and medical transportation vehicles. Perhaps not the sexiest market to be in, but when you are boring, you typically have little competition and little threat of future competition.

The Chef's Warehouse (CHEF) is a watch list stock for me. After going public to an optimistic Mr. Market, the shares have declined to a 52-week low of $17 from $30. The business is still being valued at 25x earnings, a little too rich for this particular business. But CHEF is a specialty distributor of food products in the U.S. and with the growing appetite in the country for specialty foods or healthier options, niche players like CHEF can make a mark. Still, I'd like to see the price get better before I get really excited. I could see a name like Sysco (SYY) or United Natural Foods (UNFI) becoming interested in a company like this. 

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