Diamonds in the Rough?

The last few days we have restricted our filters to only large cap stocks, but we are switching things up. Today, we focused our screener on small cap stocks that may be flying under the average investor’s radar. Looking at stocks with less than $1 billion market capitalizations, we have also filtered for those stocks that the Motley Fool CAPS crowd sentiment data is most bullish on. As you may be aware, CAPS is a simply survey that asks visitors to the Motley Fool’s website whether they believe the stock they are looking at will underperform or outperform the market. After that there is a more complicated mathematical process that weighs previously successful “fools” ratings more heavily than someone with no track record or a less successful track record. The result is the web’s best proxy for investor’s sentiment on individual stocks, which we like as a tool for taking the market’s pulse on a stock.

In addition to the criteria above, we also thinned the results by stocks that have been mentioned in the financial news over the past thirty days via RazorWire. That could mean financial television or the various impactful investing blogs that we track. Because these stocks have been mentioned, we at least know that there may be a catalyst that is attracting some attention to each of these small cap stocks.

The fact that these stocks are so loved by the CAPS crowd (5-stars) could mean a number of things. First, because they are small caps it is possible that they are only attracting the attention of investors already long in the stock, of course these investors would be more likely to rate the stock more positively. Alternatively, because the crowd is so positive these could be great “story stocks” which have a business model that makes a lot of sense, but in some cases they have not hit their stride yet. Surely there are other scenarios as well, but in total 27 stocks met this screener’s criteria. Most of them received the Ockham Fairly Valued rating, but below we briefly delve into 4 stocks that Ockham sees as Undervalued or Overvalued and also have a decent number of opinions registered on CAPS.

Among the screens interesting findings:

Amsurg Corp. (AMSG) – Amsurg operates ambulatory surgery centers and works to identify and acquire specialized medical practices with a special focus on gastroenterology and ophthalmology. The stock has underperformed the market for the majority of the last year, and all the while it has grown its fundamentals which makes it quite cheap on both price-to-cash earnings and price-to-sales basis. Based on our ratings methodology, AMSG is Undervalued. We think it is reasonable to believe that this small hospital operator will in fact benefit from healthcare reform as ambulatory surgery is generally a cheaper alternative to surgery in a bigger hospital. Although that increase in business may not be relevant for a few years, so for now investors may have to settle for revenue growth in the high single digits. At this valuation, we think that AMSG has a great chance to outperform their benchmark despite recent conservative guidance for full year results.

The First Bancorp, Inc. (FNLC) – This small regional bank in Maine is known for its conservative lending practices, but like so many others risky credit conditions have affected their loan portfolio. Still, while protecting against non-performing loans has pressured earnings there were much fewer write-downs than at many of the larger banks because of their conservative nature. In the most recent quarter, non-performing loans of 2.46% compared favorably to the peer average of 3.59%. The relative safety of FNLC also means that as credit trends improve they will likely benefit less than some of the major banks, but there is something to be said for stability in a financial stock. Income investors will love their 5.1% yield and may be enticed to sit on this Undervalued stock and reap the payouts as the stock starts to work its way towards our rationally expected price range of $17.70 to $22 per share.

Netgear (NTGR) – Netgear, a small cap which makes networking equipment for homes and small businesses, is one of the stocks that CAPS users and Ockham valuation disagree on. Coming into the day Netgear had returned 30% so far in 2010, although as of the afternoon it had given back more than 7%. After a rough sales slump last year, consumers and businesses are once again spending again on networking equipment and sales are expected to make up for last year’s declines and then some in fiscal 2010. This should put Netgear back on the growth trajectory it had established before the great recession. So, fundamentally we think the company is strengthening, but according to our methodology the stock has just gotten a little too hot and could use a breather. We will certainly consider an upgrade to Fairly Valued in an upcoming report, but for now we are reaffirming our Overvalued stance on Netgear.

Harry Winston Diamond (HWD) – Harry Winston Diamond is a diamond specialist that has both mining and retail operations. Being a high-end jewelry retailer has helped HWD recovery from extremely low prices its stock saw just over a year ago (at one point the stock hit $2). Back then the stock was certainly oversold, but that has come full circle as it started the day well over 500% higher. Our primary concern remains lack of earnings to show after this huge stock price run-up. Current analyst’s estimates do forecast a profit of 12 cents per share this year and 35 cents in fiscal 2012. These are an improvement from a loss of 99 cents per share last year, but we still think it is too risky a stock at over 30x 1-yr forward earnings estimates. Our current Ockham valuation remains Overvalued and will stay that way unless the price drops or earnings rebound more strongly. We would recommend waiting for this stock to drop back into the single digits before considering buying this diamond in the rough.

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

Ockham Research provides its research in a variety of forms and products including our company specific reports, portfolio analytics tools, newsletters, and blog posts. We also offer a white labeling research solution that can give any financial services firm their own research presence without the time and cost associated with building such a robust coverage universe of their own.

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