Micro-cap stocks are a favorite place to look for attractive investment ideas, because they get little attention. The vast majority of investment capital is conditioned, and often regulated, to look at stocks with minimum market capitalizations and most micro caps fail to make the cut.
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Individual investors are often at a disadvantage in the marketplace going up against the big players. When it comes to micro-cap stocks, investors get to hunt in areas where the market is paying little attention. The result is often a very attractive investment opportunity. Lack of attention is why an opportunity like Homeowners Choice (Nasdaq:HCII) exists. HCII is a high quality insurance company operating in Florida. The business has an excellent balance sheet and management that is very disciplined. The company recently announced a dividend increase creating a yield of over 6%; shares trade at about $9.50 for a P/E of close to 10.
WPCS International (Nasdaq:WPCS) is a micro-cap company that offers design and engineering services for construction, power and wireless communication markets. Last year was a tough year for WPCS, as cost overruns hurt margins, but the company continues to book new business and EBITDA is growing. Shares trade for about $1.68, or a market cap of $12 million, against book value of over $20 million or $3.39 a share. (For related reading on EBITDA, see EBITDA: Challenging The Calculation.)
Risks to Know
In investing, there can be safety in size. A large, well-established business with a strong balance is better equipped to withstand economic and market shocks. Market caps have no such insulation and can often be volatile investments to hold. Many such micro caps went bust during the recession when the economy started to contract. One such name that managed to resurrect itself is US Concrete (Nasdaq:USCR). After emerging from bankruptcy and restructuring its debt, US Concrete has given itself plenty of time to benefit from an increase in infrastructure construction. The company has a market cap of $44 million.
While it may not be necessarily accurate to compare USCR to larger names like Cemex (NYSE:CX) or Martin Marietta (NYSE:MLM), shares in USCR look cheap in comparison. US Concrete's smaller size may certainly warrant a discount, but its worth noting that USCR shares trade for about six times EV/EBITDA compared to a little over 11 for Cemex and about 13 for Martin. All of these companies will benefit from a recovery in construction, but few eyes are on USCR. (For related reading, see Relative Valuation Of Stocks Can Be A Trap.)
The Bottom Line
Diligent investors will find many fertile ideas when looking for micro caps. After all, many of today's great businesses were much smaller many years ago. With no analyst coverage, micro caps can offer some of greatest price to value discrepancies in the stock market.
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At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.