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MagicDiligence (< 20)

4 Interesting Small (but not Micro) Cap Magic Formula Stocks

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March 23, 2011 – Comments (1) | RELATED TICKERS: KLIC , USNA , EGY

The Magic Formula Investing (MFI) strategy is simply a ranking system. Any particular universe of stocks can be ranked in the strategy's fashion - a composite of highest earnings yield and highest adjusted return on capital, both factors equally weighted. You can apply the strategy to rank any "basket" of stocks, ranging from entire exchange listings (or groups of exchange listings), to a pre-screened list of stocks, and so forth. The possibilities are limitless.

The official MFI site allows users to rank all U.S.-listed stocks, separated only by minimum market cap. So, for example, choosing the top 50 stocks with a minimum of $100 million market cap will produce a much different list than choosing the top 50 with a minimum $1 billion market cap. This is useful, as many investors are uncomfortable buying issues of thinly traded, micro-cap stocks that they may not familiar with (even though small-caps drastically improve performance).

MagicDiligence uses three screens in particular to search for stocks to recommend: the top 50 stocks over $50 million market cap (the "small cap" screen), the top 50 over $1 billion ("mid cap"), and the top 30 over $3 billion ("large cap"). By combining the three, we get a good mix of cheap, quality stocks ranging from tiny unknown firms to ultra large caps.

However, sticking to these three screens means that a few stocks will slip through the cracks. The market capitalization range that falls through the cracks most frequently are stocks in the $250 million to $750 million range, a range that many investors find intriguing for investment potential. Using the official site and running several screens between these ranges, I found 4 interesting MFI stocks that were not screened by my usual methods. Small-cap investors may want to take a closer look at them:

Kulicke & Soffa Industries (KLIC)

Market Cap: $630 million

Adjusted Earnings Yield: 28.7%

Adjusted Return on Capital: 72.3%

Cash / Debt / Current Ratio: $203.6m / $100.1m / 5.31

5-year Expected Growth Rate: 13.5%

Dividend Yield: N/A

Piotroski Score: 8.5

Comments: K&S is a semiconductor equipment company, one of many in the Magic Formula screens right now. K&S's specialty is selling tools for the bonding process, where the semiconductor device itself is connected with the containing plastic package. Semi equipment is a very cyclical business, and we are coming off a boom year, where K&S more than tripled revenues from 2009. The company has a good balance sheet and an emerging opportunity in LED bonders, but many analysts expect chip equipment demand to fall off significantly in 2011. Even so, the stock looks oversold.

USANA Health Sciences (USNA)

Market Cap: $560 million

Adjusted Earnings Yield: 13.2%

Adjusted Return on Capital: 103.4%

Cash / Debt / Current Ratio: $24.2m / $0 / 1.39

5-year Expected Growth Rate: 14%

Dividend Yield: N/A

Piotroski Score: 6

Comments: USANA is a direct marketing firm that sells nutritional and personal care products, under the labels USANA Nutritionals and Sense, respectively. The bulk of the product lineup are vitamin supplements and skin/hair care. The company sells worldwide, with a significant presence in China and Southeast Asia. While I've been generally wary of direct marketing business models, the fact is that the others screened by MFI have performed very well (such as Nu Skin (NUS) and Pre-Paid Legal (PPD)). These consumer-based products also have the advantage of being a fairly stable source of cash flows.

VAALCO Energy (EGY)

Market Cap: $402 million

Adjusted Earnings Yield: 25.2%

Adjusted Return on Capital: 67.6%

Cash / Debt / Current Ratio: $91.2m / $0 / 3.95

5-year Expected Growth Rate: 2%

Dividend Yield: N/A

Piotroski Score: 7.5

Comments: VAALCO is a small, independent oil driller, operating 4 fields offshore of Gabon, Africa. Several new Gabon wells were drilled in 2010 that should allow the company to start increasing production after several years of stagnation. The recent acquisition of 640 acres on the Granite Wash formation in Texas are expected to be drilled this year. Higher production and higher crude prices are a good combination for higher stock prices, and VAALCO's strong balance sheet provides protection in the event of a downturn in oil.

Dolan Corp. (DM)

Market Cap: $345 million

Adjusted Earnings Yield: 11.7%

Adjusted Return on Capital: 139.3%

Cash / Debt / Current Ratio: $4.9m / $139.2m / 1.03

Dividend Yield: N/A

Piotroski Score: 7.5

Comments: Dolan is a two-headed company. The biggest head (> 50% of sales) is providing mortgage default processing services to lenders and lawyers for residential real estate in some of the most hard-hit states (CA, FL, NV, etc.). The other half publishes business journals and targeted commercial newspapers. Dolan has thrived throughout the housing bust, with revenues more than doubling since 2007. Investors are worried about the default business slowing down, but Dolan recently guided to a 8% gain in sales and 17% gain in EPS for 2011. Given the huge clog in the mortgage default pipeline, I'd say there are still several years of outsized business to be had here.


Steve owns no position in any stocks discussed in this article.

 

1 Comments – Post Your Own

#1) On March 23, 2011 at 10:59 AM, bluefog33 (< 20) wrote:

Looking for insight on Nike Vs. UnderArmour as a stock pick for the long term. I understand that Nike is the Giant, with dividends, but wondering how UnderArmour may fair in the future.

Thanks! 

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