Two Little Gems Are Hidden Amid Small-Caps

Sometimes, the under-research companies offer the biggest opportunities.

Market inefficiencies, when they occur, should be exploited whenever possible. The market becomes inefficient when there is extreme uncertainty or fear. Additionally, the market becomes more and more inefficient when fewer and fewer eyeballs are looking. In the stock market, the eyeballs decline proportionately with the size of the company. Every single analyst eyeball is watching or knows about Action Alerts PLUS portfolio holding Apple (AAPL) or Growth Seeker portfolio name Amazon.com (AMZN).

But there are no eyeballs on a business like cable connector manufacturer RF Industries (RFIL), a $20 million micro-cap. Obviously, a company of that size is not meaningful for 95% of investment capital. But for the 5% or so for which such opportunities make sense, these small fish can produce big-time gains. Over the past month, RF shares have dropped by nearly 50%. In first fiscal quarter of 2016, the company reported an operating loss of $600,000 and as a result the dividend was slashed.

The dividend reduction is not as significant, because RF has never had a set dividend policy; it had a rather discretionary one. However, for years the annualized rate has been about $0.25. For the first fiscal quarter of 2016, the quarterly dividend was $0.02. So the market has annualized the dividend at $0.08 and views the quarterly loss as a sign of trouble. RF's first quarter is typically its slowest. At the current share price, the current yield is nearly 4% and shares trade below book. RF has a very consistent history of profitability and dividends. So the current price decline bears watching closely.

Few eyeballs are also on Kindred Biosciences (KIN), an animal health biotech trading below cash value. At the current market cap of $70 million, there are $83 million in cash and no debt. To be sure, it generates no revenues and burns about $20 million a year in cash, but that number is likely to decline in 2016. Unlike most biotechs that require hundreds of millions of dollars to bring a drug to approval, the figure for Kindred is around $5 million. The company has over a dozen potential candidates, which as animal drugs have a significantly less cumbersome and shorter process of reaching the finish line. Kindred has a long life to reach success. And at the current moment, you are getting that opportunity with a healthy safety margin.

It is worthwhile to focus effort and energy looking under small cracks. Very few are looking, so the odds are good that you find a hidden gem.  

At the time of publication, Sham Gad was long KIN, although positions may change at any time. Please note that due to factors including low market capitalization and/or insufficient public float, we consider RFIL, KIN 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.