We developed a list of small market-cap stocks that meet the definition of a quality stock as provided by Robert Novy-Marx of Rochester University. According to Cliff Asness of quantitative investment firm AQR Capital, the small-stock anomaly is not only still in existence, but when you apply it to these stocks that are higher quality, it's larger than ever.
We looked at a couple of examples of these stocks, but now it's time to get scientific in our search for market-beating stocks. I am a value guy at heart ¿ and we will get to the value stocks this week ¿ but there are other proven methods for beating the market. I want to examine the list of small-cap quality stocks from all angles to see what we find that can help us make money this year, regardless of our approach to investing.
I'm going to start with those stocks showing price and earnings momentum. There is a ton of academic evidence to support the idea that stocks with strong earnings and six-month price momentum perform very well over the next six to 12 months. Rather than reinvent the wheel and add more criteria to my screen, I am going to cheat in the category of stocks. Louis Navellier has a great tool on his website that ranks stocks based on these factors, so I'm just going to dump the list of small-cap quality stocks into his system and see which ones come out with high scores.
I was talking with some friends about finding those stocks that would most benefit the big-picture view of the world. At the time, I said the real growth industry should be those that directly benefited from the growth of government at all levels. Willdan Group (WLDN) is such a company. It provides technical and consulting services to public agencies at various levels of government. Willdan works on homeland security projects, building and safety services, code enforcement, energy efficiency and finance services. If governments are spending money on it, the company has a program to assist them in spending it. Earnings are up more than 100% so far this year and the stock has gained more than 50% in the last six months. Willdan Group generated $40 million of profits in the past month on just $50 million of assets, so it is definitely a quality stock and the market-cap is just $96 million right now.
Flannigan's Enterprises (BDL) owns liquor stores, restaurants and a "gentleman's club" in South Florida. Business is pretty good for the Fort Lauderdale-based company as earnings were up more than 100% in the most recent quarter. The stock of this interesting collection of businesses has gone up by 140% in the past six months, so it has strong price momentum as well. Although a company whose offerings include Big Daddy's package goods and a strip club may not immediately bring quality to mind, Flannigan's produced $22 million in profits on just $50 million of assets, so it meets our definition.
Misonix (MSON) is more of what we usually have in mind when we think of small-growth stocks. It makes ultrasonic products for spine surgery, skull-based surgery, neurosurgery, wound debridement, cosmetic surgery, laparoscopic surgery and other fun procedures. In the past 12 months, it has produced gross profits of $12 million using just $19 million in assets, so it's a quality stock. Profits are up well over 100% this year and the stock has soared 87% in the past six months, so Misonix clearly has price and earnings momentum.
If you asked me to name a growth stock without looking at recent results, Superior Uniform Group (SGC) would never cross my mind. The company makes uniforms for hospitals, hotels and a host of other retail and industrial businesses. Business is very good for the company, with profit growth of 87% this year, and the stock is up almost 100% in the past six months. Superior Uniform produced gross profits of $66.5 million on assets of $136 million in the past 12 months, so it fits our definition of a quality small-cap growth stock.
I have spent a bit of time with Cliff Asness' recent study on small-cap stocks, "Quality Minus Junk," and am quite convinced that adding a quality component to a small-cap portfolio can improve performance for both growth- and value-oriented investors. It is a bit of work to uncover these gems, but it's worth the investment.
It works for income-seeking investors as well, and I will look at some of small-cap, high-yield quality companies on Wednesday.