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Pawnshops? Payday Loans? Paydirt.

It's time to celebrate: After a long and winding search, I've finally found two small-cap stocks with big value and growth potential. Ironically, they turned up in my own backyard; I've written about both of these companies before. Both issue payday loans, and one also owns pawnshops.

Yes, I'm once again talking about First Cash Financial Services (Nasdaq: FCFS  ) and QC Holdings (Nasdaq: QCCO  ) . In my opinion, their competitors EZ Corp (Nasdaq: EZPW  ) , Cash America International (NYSE: CSH  ) , Advance America (NYSE: AEA  ) , ACE Cash Express (Nasdaq: AACE  ) , and Dollar Financial Corporation (Nasdaq: DLLR  ) aren't in the same league, for reasons I've explained in other articles.

Here's another reason why I like these companies, particularly First Cash: After the FDIC suspiciously curtailed these companies' ability to lend in states like Texas, management found a brilliant way around those restrictions. I love a company that charges headlong into adversity and quickly solves a crisis. That's the kind of management I want to see running my business.

But just to make sure I'm on the right track, let's check out the numbers. Here's First Cash:

  • Market cap under $2.5 billion? Yes, $360 million.
  • Historical and projected earnings growth of 15%? 37% the past five years, 19% for the next five.
  • Positive free cash flow? Yup, $34.5 million over the past 12 months.
  • Market cap/FCF < P/E? Yes, that ratio comes in at a spectacularly low 0.61.
  • MC/FCF/five-year growth rate < 0.66? Wonders never cease -- 0.54.
  • Insider ownership of 10%-50%? Yes -- 24%, very solid.
  • Net margins of 7% or more? Yes. An excellent 12.6%.

Not too shabby. As for QC Holdings:

  • Market cap under $2.5 billion? Yes, $289.9 million.
  • Historical and projected earnings growth of 15%? 37% the past five years, 19% for the next five.
  • Positive free cash flow? Yes. $6.5 million for the last 12-month period for which cash flow data is available.
  • Market cap/FCF < P/E? No, 44.6 compared to 17.
  • Insider ownership of 10%-50%? More like 69%. But let's not call that bad.
  • Net margins of 7% or more? Yup, 16.40%.

Why isn't free cash flow here as high as we might like? The company is aggressively expanding, but doing so without any debt, and still carrying $32 million of cash in the bank.

On top of all this, QC Holdings is buying back $10 million in stock, which would amount to about 4% of shares outstanding. In both companies' recent quarterly reports, you see confirmation of a trend in this sector: growth, in the form of outstanding same-store comps. How outstanding? Try 15% and higher. People are flocking to this product; despite what critics say, they seem to want it.

For good measure, I'd like to quickly examine dilution. Over the past two years, First Cash shares outstanding have increased at a rather ugly average rate of 7.9%. But diluted shares outstanding actually decreased by 7,000 shares in the course of fiscal 2004. Though this may a bit of a blip, dilution appears to be under control now.

As for QC Holdings, they're a bit harder to get a handle on, since they just went public last July. As of June 30, 2004, they had 12.924 million shares outstanding; one year later, they had 21.537 million. That's an annual rate of about 40%. Not great, but given all that debt-free expansion, I still think the company bears consideration.

Does this mean you should run out and buy these stocks? No! Do your own homework -- don't rely on my suggestions alone. Before I formally recommend these puppies to the folks at Motley Fool Hidden Gems, I plan to wait two quarters to see how the business is going to shake out. Although management has outmaneuvered the FDIC, I want to make certain they're able to execute on their business plan over a slightly longer period.

Further Foolishness on payday lenders:

Searching for even more small-cap stocks with big growth potential? A subscription toMotley Fool Hidden Gemscan help you find great companies the market overlooks. Try it free for 30 days, no strings attached.

Fool contributor Lawrence Meyers does not own any stocks mentioned in this article, and advises you to meticulously research stocks on your own.

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  • Report this Comment On April 09, 2014, at 1:40 PM, rpace1906 wrote:

    I've never really fully understood what payday loans until this morning. I heard my buddies talking about them last night, and since I'm a curious person I thought I would find out they were exactly. So after finding this and, I have a much better understanding of what they are, and how they work. Thanks so much for sharing this, it helped a ton!

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