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  1. Home
  2. / Investing

Look Off the Beaten Path for Growth

Finding thriving companies that are off Wall Street's buy list can eventually bring huge profits.
By TIM MELVIN Jan 03, 2012 | 01:00 PM EST
Stocks quotes in this article: EBSB, KEM

 Today's chilly temperatures as well as the start of a cold have eclipsed my usually sunny disposition. As I walked the dog this morning, I decided that I would take my mood out on the world and write about short candidates for the new year. However, I realized that probably isn't the best way to start the year off, so I will hold that article for a day or two.

Since I prefer to start the year with a more upbeat look at the world and the markets, I decided to run a screen that looks for what I like to call undiscovered growth stocks. These companies have shown decent revenue and earnings growth over the past five years and are expected to grow at a decent rate in the future and are still trading at a less than $15 a share. Most of these companies are either completely off Wall Street's radar screen or have had a short term stumble that has caused the Street to turn its back on the shares. Given my valuation sensitivity, I may not be running out to buy these stocks, but they are worth following for an entry opportunity. More growth oriented readers may find them of interest now.

The first stock on the list that catches my eye is a small bank in Boston. Of even more interest is that Meridian Interstate Bancorp (EBSB) has done a first-step conversion but still has a mutual holding company structure. The company has been using the cash from the first stage of the conversion to buy back stock and open new branches. In a recent Barron's article, analysts for Stern Agee estimated that the company's tangible book value upon completion of the second stage of conversion will be about $16. So with the shares trading around $12.50, I might be willing to buy this stock now.

The bank has remained profitable throughout the credit crisis. Growth has been impressive, with earnings growing by 24% a year for the past five years. The bank just announced its fourth buyback program, covering 904,000 shares of the stock. Buying shares of the Mutual Holding Company in advance of the second-stage conversion could be a very profitable endeavor in the new year.

Kemet (KEM) is a company I have owned in the past and could well end up owning again this year. The company makes capacitors, which are electronic components that store filter and regulate electricity. The devices are used in just about all devices that have an electrical current. To capture higher-margin business, Kemet has been moving forward in many of the specialty segments of the market including green energy, energy exploration, lighting and military applications of its products. Since 2008, the company has been paying down debt and building its cash position to strengthen the balance sheet. At year-end, the company has $278 million of debt and $152 million of cash compared to $413 million of debt and just $81 million in 2008 so they have made substantial progress. Revenues at the company have grown by 15% a year for the past five years, while earnings per share (EPS) have leaped by more than fivefold. Trading at 1.4x tangible book and with an Enterprise Value-to-EBITDA (earnings before interest, taxes, depreciation and amortization) ratio of less than 3, the shares are worth watching this year for a chance to buy for the long term.

My screen also produced a list of solar related names. Most of us without specialized knowledge of this sector should avoid it for the foreseeable future. It takes a very healthy global economy to support the tax breaks and government subsidies needed to make solar a profitable industry. As that does not exist right now and I think solar companies will have a tough time gaining any revenue or earnings momentum anytime soon. I do intend to revisit this industry when some of the profitable suppliers trade below book and near net-cash levels. I think it may get there later this year.

Finding companies that are growing and are off Wall Street's buy list can bring huge profits when these names inevitably gain institutional attention. It is a productive activity and even deep-value investors should keep these on their list of buy candidates.

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At the time of publication, Melvin had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity

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