3 Small Companies to Consider If You're Patient and Aggressive

 | Jul 29, 2016 | 2:00 PM EDT
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I've spent a lot of time talking about private equity in the past week as the major PE firms reported their most recent results. All of them reported fantastic results from their buyout funds. The combination of valuation and time was helping drive returns that are beating even this overheated equity market.

Last year, Brian Chingono of the University of Chicago and Dan Rasmussen of Verdad Fund Advisors released a paper titled "Leveraged Small Value Equities." They found that buying small companies that have some leverage on the balance sheets and trade at low valuation allows individual investors to replicate and even exceed private equity-type returns.

I ran a screen this morning that looked for companies trading at low EV/EBIT ratios with a debt to equity ratio of greater than 1. I only wanted to look at companies where the fundamentals were improving and the prospects were good, so I added a criteria that the company had to have a Piotroski F-score of 5 or greater. There were some interesting companies on the list that I think could provide returns like those enjoyed by the private equity funds and are worth considering by patient aggressive investors.

Shares of AEP Industries (AEPI) have recovered from the lows but still trade with an EV/EBIT ratio of just 7.6. This company makes flexible plastic packaging films that are used for industrial applications, wrapping cars and boats for transportation or storage, trash bags, retail lawn and leaf trash bags and a host of other uses. Business is pretty good and the company recently reported the highest adjusted EBITDA levels in company history.

Company officials pointed out there is a lot of resin capacity coming online over the next few years that will lower raw material costs and should drive higher profits for the company. That, combined with a slow and steady economic recovery, should allow AEP Industries to see higher earnings that result in a much higher stock price over time. AEPI has an F-score of 8, so the fundamentals are strong and prospects are improving for the company and the stock.

Commercial Vehicle Group (CVGI) has two businesses. The global truck and bus segment provides seats and seating systems for medium- and heavy-duty trucks. This division also makes things like armrests, map pocket compartments, carpets and sound-reducing insulations and instrument panels for the same market. The global construction and agriculture segment provides electronic wire harness assemblies that provide connection for electronics applications for commercial vehicles. This is a very private equity-like company, as business has been slow due to delayed orders and the company is restructuring to cut costs. The stock trades with an EV/EBIT ratio of 7.2 and an F-score of 6, which tells us the restructuring moves are helping drive fundamental improvements.

My favorite company on the list is one that first popped on my radar screen when David Nierenberg of D3 Funds started buying the stock. He still owns over 500 shares of Malibu Boats (MBUU) and it will be interesting to see if he bought more during the selloff following an earnings miss in the second quarter. The company makes performance boats for waterskiing, wakeboarding and just bouncing over the water at high speed. Although the results were short of Wall Street expectations, CEO Jack Springer was pleased with the results, telling investors, "Through a disciplined operating strategy, we continue to execute at a high level, and perform well despite substantial international headwinds and an uncertain economic environment. This is the ninth consecutive quarter where we delivered our overall financial results that were in line or better than our internal forecast." A strong dollar has not helped Malibu Boats; most of the weakness has been from international markets while the U.S. market has performed very well. The company trades at an EV/EBIT ratio of 7.5 and has a Piotroski F-score of 5, so the fundamentals are solid.

My big caveat here is that the S&P 500 is up 6.6% in the past month and the Russell 2000 has jumped ahead by 10%. There is no rush to put money to work at these levels, and although all three stocks pass the screen, Malibu Boats is the only one I would be comfortable starting to buy at the current price. The other two should go onto your watch-and-wait list for an opportunity to buy at lower prices. Also keep in mind that we have a very long holding period in mind and looking to own these companies for five years or longer to capture returns measured in multiples, not percentages.

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