[ed note: This teaser pitch is exactly the same as one that started running in late February this year, so we’re just re-running our teaser solution from February 28, 2013 below — the basic idea of the investments is the same, the four teased stocks are exactly the same. More on how those stocks have done at the bottom, but otherwise we haven’t updated this article.]
The folks at Investing Daily are launching a new letter that’s promising a “Magic Formula” for finding stocks that can deliver huge returns. The letter is edited by Jim Fink, who I don’t think I’ve ever written about — he’s been writing an options income letter for a while and apparently also contributes to their flagship letter, Personal Finance.
And now he’s got a service that’s hunting the next Monster Beverage, Priceline.com, Deckers, etc … choose your favorite 3,00%+ percent gainer over the last decade, and you can bet there are plenty of folks looking for how to target those guys ahead of time.
That’s where the “90% of top stocks” bit comes from, by the way — the spiel is that 9 of the top ten stocks over the last ten years started out as very small cap stocks, with market capitalizations of under a billion dollars, so therefore 90% of “top stocks” share this “secret” that most companies who show massive returns in a short time period start out little. The exception, by the way, is Apple — it was a multi-billion-dollar company ten years ago, though in going from $8 billion to $500 billion in market cap it certainly outpaced almost all other stocks. The others in the top ten that Fink cites, by the way, are MNST, DECK, GMCR, NEU, CLF, SCCO, MIDD, CALM and QSII.
Which gives me plenty of opportunity to regret the picks I sold too soon on that list, but that kind of self-flagellation won’t get us very far.
So yes, the idea is that you want to find small stocks that can grow dramatically over the next decade — that’s not surprising, the long-term outperformance of small cap value stocks, on average, has been known for a long time. And Fink, of course, thinks he has some good candidates for you that he’ll share in this new letter.
Or, as he puts it …
“This same strategy still works today because it’s based on timeless qualities. Agile small-cap value stocks still create new millionaires faster than any other investment on the planet. And the best news is… plenty of these stocks are out there today.
“If you don’t believe me, just look at the numbers. According to Bloomberg, 1,003 stocks are up 100% or more this past year. 189 stocks are up at least 10 to 1. And that’s in the U.S. alone. Include foreign markets and you’re looking at 389 10-baggers in the past 12 months. So it can and does happen—a lot.
“In a minute I’m going to tell you where I’m finding stocks like that now.Are you getting our free Daily Update
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“I’ve discovered dozens of companies in position to deliver 10-year returns anywhere from 1,000%, 2,000% and a few even higher.
“Will they all be big winners? Of course not.
“But I’ve identified a handful of these “Buffett-quality” Roadrunner Stocks with the best odds for success in a new Special Report.”
So … assuming that you don’t want to shell out $127 for the introductory price on this new letter, shall we find out what that handful of stocks are? Heck, maybe you’ll be so impressed with them that you’ll want to subscribe … or maybe you’d just like to have a few ideas to sniff on your own.
His basic pitch is, “Think small and think cheap” … and he cites some of the things that make these kinds of stocks compelling, like the fact that they tend to be domestic companies with few constraints to growth, they watch their cash closely because they have to, they often have large insider ownership, and they’re far more nimble in changing industries than are their larger counterparts.
He says he’s got eight “strengths” he looks for in his stocks, here’s the rundown:
- “Unique product or service. I like small companies with something exceptional to offer. Uniqueness is a competitive advantage, because it means that consumers can’t get what your company sells from anybody else. When there’s no competition, a company has almost unlimited pricing power.
- Impressive management. The greatest idea or breakthrough product means nothing unless you’ve got smart, dedicated people running the show—preferably the founder. I’ve made more money investing in firms with sharp managers and so-so products than in companies with great products and mediocre management. And the smaller the company, the better the management has to be.
- Strong earnings-growth prospects. I want companies whose profits are likely to grow by 15% or more for at least the next five years.
- Low price-to-earnings ratios—ideally, lower than the company’s growth rate. I’m especially fond of “shoe-size” P/Es in the 9 to 11 range.
- High and rising operating margins. Earnings can be manipulated. Operating margins can’t be. That’s why they’re a great measure of a company’s true profitability.
- Low institutional ownership. I want to own a stock before Wall Street piles in and drives up the price.
- Low debt. There’s no magic number here, but too much debt can strangle a company. I never buy a stock with more debt than equity
- High insider ownership. I want management to be partners with us on a stock. It’s a key Buffett rule: Owner-operators want the stock to go up as much as you do.”
A reasonable list of criteria, not many folks would argue that those aren’t good qualities for your stocks to have.
And the goal, we’re told, is 25% appreciation per year across this new portfolio — a nice number to shoot for.
He says that 80% of his trades have been winners over the past year, not sure if that’s in his options income portfolio or if those are stock picks … or, indeed, what he means by “winner.”
So what are the stocks he hints at in this teaser ad as his “top four buys now?”
“High-tech life-savers. If you’ve ever been blinded at night by someone tailgating you with their brights on, you know it’s a real safety hazard. This company’s solution: rearview mirrors that automatically dim when they sense bright headlights behind you. Our pick’s high-tech mirrors are already in 23% of cars worldwide, but that will likely jump to 45% in 10 years. That will generate more new revenue than the company’s entire market cap right now. So the stock-price appreciation potential is tremendous. Now is the time to jump into the stock while it is unusually cheap, thanks to depressed exports to Europe. Once the Euro economy rebounds, the stock should return to its traditional P/E multiple, which would push the stock up 60% in a hurry.”
This one is almost certainly Gentex (GNTX), which is indeed the dominant automatic dimming mirror supplier — and in their investor presentation they do say that these kinds of mirrors (not just from them, but from all competitors combined) are in about 23% of vehicles now and could be in 45% of vehicles in a decade … which, at $100 a vehicle estimated cost (that might be just a fancier rearview mirror, or a combination of auto-dimming interior and exterior mirrors) would mean a $3 billion annual revenue potential for the sector.
And yes, Gentex has a market cap below that now, at about $2.7 billion. So they’re certainly not teensy, but are arguably in the small cap neighborhood (different people use different cutoffs, but usually around $2-3 billion they start to be called mid-cap stocks).
Interestingly enough, they don’t fit perfectly in Fink’s criteria — the PEG ratio is higher than one (meaning the expected growth rate is lower than the current PE ratio), the PE is not in the “shoe size” area of 9-11 but the forward PE is now 14 (as a guy with a size-13 foot, I can accept that). And operating margins have actually been coming down a little bit over the last two years — not dramatically, and they’ve certainly done well with the resurgence in vehicle sales over the last year or two, but they’re not getting margin expansion just yet. I see a lot to like in this auto tech stock, they’re spending heavily on R&D for other advanced features too (like rear and front camera assists and sensors, more electronics crammed into the rearview mirror, etc.), they have raised the dividend now three years in a row and have a decent near-3% yield, and they’re in a growing segment. Don’t know them well, and they’re neither tiny nor dirt cheap, but this looks like an appealing one for a bit more research.
“The Costco of Latin America that could jump 20-to-1. The largest membership warehouse club in South America and the Caribbean, this firm serves 1 million cardholders in 12 countries. But it’s more than just a Costco wannabe—it was actually spun off from Costco and is run by former Costco managers. If it can mimic Costco’s North American success in Latin America, the stock will be a homerun over the next decade. My metrics suggest the stock could grow 20 times in value from here.”
This must be PriceSmart (PSMT), a stock we’ve covered before a few times and that is also not much of a fit on those benchmarks — it’s growing fast, indeed, but is priced for that growth with a forward PE well into the 20s, and PSMT’s operating and profit margins that have been quite consistent and pretty flat over the past five years even as sales have grown nicely. They do have a very high insider ownership, as well as a pretty large short position in the shares (about 10% of the stock is sold short, meaning a substantial number of investors are betting that the shares will fall — that’s not that unusual for stocks that tend to swing pretty widely on earnings and news and that are richly priced like PriceSmart). I shared some more detailed thoughts about this one when writing about a Hilary Kramer teaser last Summer, but don’t have much of an opinion on the stock for you today. It hasn’t moved much since then, incidentally — it’s up about 10%, but so is the broader market, and they’ve “beaten” on their last two quarters, but not dramatically.
“Policing Obamacare for profits. Now that Obamacare is a reality, 30 million more Americans will be consuming government-subsidized healthcare. This means a whole lot of work making sure providers are properly paid. Our pick is in the business of ‘payment integrity.’ In other words, it’s a fraud-buster that has been helping government agencies and corporations save money since 1974. And business should be GREAT going forward.
“60 Minutes calls Medicare fraud ‘one of the most profitable crimes in America.’ So this company’s opportunity is immense. By 2015, the government will spend $1.3 trillion a year on Medicaid and Medicare, and $107 billion of it will end up as waste or fraud. This is the company’s bread-and-butter business. Last year alone, its clients recovered $2.5 billion, and saved $7 billion more. Considering its market is about to explode from $9.5 billion to $160 billion, I see tremendous growth ahead.”
This one, sez the Thinkolator, must be HMS Holdings (HMSY) — which, again, is big for a small cap (market cap $2.5 billion), priced for growth,
They’ve given some recent presentations at investor conferences that you can see here if you want to get a backgrounder on them — it’s a very good story, and though I’ve spent just a few minutes taking a gander at them I do like what I see so far in terms of growth and potential growth … but it ain’t cheap with a trailing PE of 50 and a PEG ratio of about 1.3, and it also has a pretty high short interest (about 11%) and not much insider ownership (the insiders were buying a bit last Fall, but selling more recently). The shares have had a pretty bumpy ride, seeing both the low $20s and the high $30s over the last six months, I haven’t looked into them much yet but that may well be because of the fluctuating perceptions of what health care reform might mean to them (and the threats that this reform might have been rolled back last Fall). I’m adding this to the list to look into a bit more for myself, but, again, it’s not that small and it’s not at all cheap — this is a growth stock.
“Back-door ‘fracking’ play. This is the world’s largest ceramic proppant supplier, used in hydraulic fracturing to ‘prop’ open cracks in shale rock. Ceramic proppants account for 20% of the market, and their share is increasing. Because ceramics are highly permeable, oil and gas escapes to the surface more easily, and well productivity jumps 20% to 50%.
“The company has been profitable for 25 consecutive years, with compound annual growth of 20% during that period. That turned a $10,000 investment into $794,968. Thanks to today’s shale boom, the future looks just as good.”
That one, you’ll probably be unsurprised to hear, is Carbo Ceramics (CRR). I haven’t looked at them recently, though I do remember them being teased a time or two during the early days of the fracking boom and having a huge run until they peaked in mid-2011. Based on analyst expectations, this one is far more expensive than the others — it’s got a PE that’s twice the expected growth rate (a PEG of 2.0, in other words), and I don’t know what the issue was in 2011 or 2012 but their earnings and margins did decline in 2012 from the peak 2011 results. They also have a huge short interest, almost 30%, so there must be quite a bit of disagreement among investors about their prospects — I can’t pitch in with much in the way of opinion here, but from a quick glance they’re not growing fast enough to be confident about the valuation — maybe it’s the decline in natural gas fracking jobs with the fall in gas prices, maybe it’s competition from sand or other proppants, I dont know.
So there you have it — four “Small Cap Wealth Builder” stocks from Jim Fink that are teased as “small cap value” but that I’d call “mid cap growth” ideas, all interesting in one way or another, but your friendly neighborhood Gumshoe’s fifteen minutes with each of them isn’t enough to give me great confidence that I know the whole story … so I’ll toss it out to you, got any favorites among those four picks? Any that you think we’ll look back on as 1,000%+ gainers in 2023? Let us know with a comment below.
[So how have those stocks done since this article first ran (and the teaser campaign for this new newsletter began) in late February? You can always double-check on our tracking pages, but the four of them are actually doing quite well, on average — Gentex, the one that was most appealing to me (though I never bought it) is 38% higher, PriceSmart is up 33%, Carbo Ceramics is up 14%, and HMS Holdings has lost 27% of its value.
What does that mean? Well, it means that if you’d put $1,000 into each of those four stocks on February 28, when we ran our article, you’d have about $4,580 now and be up about 14.5%. No 1,000% gains here, I’m afraid, but that is a hair better than the 12.5% return you would have gotten over that same time period in an S&P 500 index fund.]
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