"Most leading brokers cannot spare the time and money to research smaller stocks. You are therefore more likely to find a bargain in this relatively under-exploited area of the stock market."
-- James D. Slater, the master investor who invented the PEG ratio.
I certainly agree.
I've shown in the past exactly why Wall Street is always behind the game in finding the small stock winners that build fortunes; since Wall Street talks in billions, stocks worth millions are just too small to move their needles ... this isn't the case for you and me.
I've also documented how Warren Buffett used these very same small-cap stocks to start his fortune.
Today, though, I want to share some of these small-but-mighty outperformers that are flying under the radar of most investors.
The outperformers
Before I show you these outperformers, let me clarify what I mean by an outperformer.
By outperformer, I do not necessarily mean a company whose stock has rocketed up in price. No, I'm talking about companies that have outperformed operationally; companies that have substantially grown their earnings ... and done so profitably. And we want these growing earnings at reasonable prices (before Wall Street catches on).
Using my Capital IQ institutional software package, I screened for the following criteria:
- Five-year trailing earnings growth above 10% (annualized).
- Five-year return on capital above 10% (average) vs. the S&P's five-year return on capital of just over 1%.
- Forward P/E ratio below 20.
I found both larger companies you've likely heard of and smaller companies you probably haven't. I'm going to share the ones you've heard of first for two reasons:
1. They provide a basis of comparison for the companies you're not familiar with.
2. Larger stocks are an important part of any portfolio -- I'm merely saying that there are compelling (read: profitable) reasons to look at smaller, underfollowed companies. More on that shortly.
Here they are (in order of growth):
|
Company |
5-Year Earnings Growth |
5-Year Return on Capital |
Forward P/E |
|---|---|---|---|
|
Apple |
67.5% |
28.9% |
18.0 |
|
Mosaic |
31.3% |
11.7% |
12.9 |
|
Coach |
20.2% |
39.3% |
16.2 |
|
Oracle |
15.5% |
15.3% |
13.1 |
|
General Mills |
13.5% |
11.6% |
14.9 |
|
Microsoft |
13.4% |
32.3% |
13.2 |
|
AutoZone |
13.3% |
30.8% |
12.5 |
|
Yum! Brands |
12.9% |
24.2% |
16.4 |
|
Accenture |
11.8% |
58.6% |
13.8 |
|
ADP |
10.5% |
21.2% |
17.1 |
Source: Capital IQ, a division of Standard & Poor's.
All of these companies appear to be kicking some serious butt without the corresponding ultra-high price tag.
If you're looking to buy some solid larger-cap stocks, these are good research candidates. But I promised you another compelling reason to look deeper, at the smaller companies other investors don't know about yet.
The reason? The biggest returns in the market come from identifying a growth story before the market catches on. If you think Apple and Microsoft are compelling now, imagine buying them 20 years ago. The companies above are all huge in size. Though they've got impressive five-year growth, their size makes it harder for them to keep up that growth. Not so with the small companies I'm about to show you.
That's why Buffett exploited these kinds of small bargain stock opportunities in the past, before he got too big to do so.
So here you go (in order of growth):
|
Company |
5-Year Earnings Growth |
5-Year Return on Capital |
Forward P/E |
|---|---|---|---|
|
American Italian Pasta Company |
101.1% |
16.6% |
10.9 |
|
American Science & Engineering |
50.9% |
15.1% |
19.0 |
|
AZZ |
47.3% |
16% |
18.1 |
|
Immucor |
33.6% |
20.9% |
17.0 |
|
Tower Group |
22.1% |
11.2% |
8.4 |
|
Net 1 UEPS |
20.8% |
18.4% |
7.8 |
|
Synaptics |
16.5% |
15.3% |
11.7 |
|
Corinthian Colleges |
15.5% |
18.2% |
7.5 |
|
UniFirst |
13.8% |
10.2% |
14.5 |
|
J&J Snack Foods |
13.7% |
12.7% |
18.6 |
Source: Capital IQ, a division of Standard & Poor's.
Very few investors are taking the time to look into these stocks -- which is a very good thing if you're trying to beat the market.
Our Motley Fool Hidden Gems analysts look exclusively for these kinds of stocks -- the small powerhouses that can turbocharge your portfolio. They've bought electrical equipment provider AZZ in their real-money portfolio -- you may have noticed in the table above that it has been growing at nearly 50% but selling for just 18 times forward earnings. I invite you to join us in hunting down these ignored opportunities with a free 30-day trial. You'll get unfettered access to all of our research and picks. Click here to get started.
This article was originally published April 21, 2010. It has been updated.
Anand Chokkavelu owns shares of Accenture and Microsoft. Accenture and Microsoft are Motley Fool Inside Value recommendations. American Science & Engineering and Net 1 UEPS Technologies are Rule Breakers picks. Apple and Coach are Stock Advisor selections. Net 1 UEPS Technologies is a Global Gains recommendation. Automatic Data Processing is an Income Investor recommendation. The Fool owns shares of and has written puts on Oracle. Motley Fool Options has recommended a diagonal call position on Microsoft and a bull call spread position on Yum! Brands. The Fool owns shares of AZZ. The Fool has a disclosure policy.
