Uncovering Hidden Value In Small Caps

By Sham Gad | June 11, 2012 AAA

One thing is certain in the investment business: size matters. The vast majority of analyst coverage and media attention is bestowed on the bigger names. More attention creates greater efficiency. Greater efficiency means less opportunity to find an undervalued stock. For the majority of investors out there, being the biggest does not necessarily mean being the best.

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Play in Your Sandbox
It would be foolish to challenge LeBron James in a game of one-on-one basketball and think you could have any sort of advantage. Similarly, it would be foolish to invest in the biggest, most widely covered stocks and think you have a leg up on Mr. Market. Odds are it would be better to create your own sandbox of investments, and look at investments that are not on the radar of Wall Street. In other words, look small.

SEE: What Is A Small Cap Stock?

Look at names like small cap retailer Stein Mart (Nasdaq:SMRT) which trades for $7.50 a share, and has a market cap of just under $330 million. SMRT offers designer fashions, shoes and other home accessories at discount prices, making the company very appealing to consumers today. SMRT is profitable, has no debt, and over $110 million in cash. Over the years, the company has used the cash for special dividend payments. West Marine (Nasdaq:WMAR) is a specialty retailer of boating supplies. The company has a market cap of $240 million and no debt.

SEE: An Introduction To Small Cap Stocks

Dirt Cheap Micro Caps
As you get smaller, the opportunities get more intriguing. Amtech Systems (Nasdaq:ASYS) is a $40 million semiconductor company. The company is profitable, and against a market cap of $43 million. ASYS has no debt and $50 million in cash, effectively handing investors a profitable business for free.

Cutera (Nasdaq:CUTR) is a global medical device company that engages in the design and development of laser- and light-based systems for aesthetic and podiatric applications worldwide. The company has a market cap of $95 million, no debt and nearly $80 million in cash. Again, the business is being given away because the market is seeing losses. Maybe the company will burn through the cash and maybe it will not. Such an intriguing balance sheet makes the company worth a closer look.

SEE: Breaking Down The Balance Sheet

The Bottom Line
Smaller cap companies can certainly pose a greater degree of risk than larger enterprises with more diverse operations. Because of risk, even quality small caps will often be neglected. Today's biggest companies were once smaller versions of themselves. The biggest returns come from hunting in the small cap arena, although greater prudence is required.

At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.

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