Recently, we have been considering adding some small capitalization stocks to our investment portfolio. Small cap stocks are very risky but we would like to take a small portion of our investment portfolio and invest it in a highly-diversified basket of undervalued small cap stocks. When we look at small caps, we look for companies trading at cheap valuations that have a stable business and a solid balance sheet. We avoid small caps trading below a $1/share or below a market cap of $100 million. In our opinion, shares below this threshold tend to be too illiquid, too volatile, and generally not worth the risk. In general, we feel that the small cap market is one of the few places where individual investors can get an edge over the large asset managers. We believe that the small cap market has some inherent market inefficiencies that can benefit diligent investors. The following stocks caught our attention recently and we have decided to share these ideas with our readers.
IDT Corporation (IDT)
IDT is primarily in the prepaid/rechargeable phone calling card business, offering both domestic and international prepaid calling plans. These calling cards are sold through a broad range of retail locations throughout the world. We were drawn to IDT because it has lots of cash and is selling at a dirt cheap valuation. IDT has a market capitalization of $326 million and a net cash position of $122 million (37% of market cap). Also, IDT has inexpensive valuation multiples with a TTM PE ratio of 6.96 and a forward (2014) PE ratio of 9.52. Another indicator of a low valuation is that IDT is selling for 4.47 times free cash flow and that it has a very attractive 4.20% dividend yield.
We believe that IDT has a good business that will growth earnings at a 10% pace for several years. In our opinion, the shares are undervalued and may be a good candidate for the speculative part of our investment portfolio. If present trends continue, we expect IDT to appreciate about 40% over the next year.
FBR & Company (FBRC)
FBR is a United States based institutional brokerage and investment banking company. One thing that caught our eye about FBR was that it has about $305 million in cash and short/long term investments. This is greater than the $255 million market capitalization of the entire company. Additionally, FBR is selling for 4.37 times TTM earnings and 6.8 times free cash flow.
With the S&P 500 index reaching new highs, we believe that FBR will benefit as the United States stock market continues to improve. FBR provides investment banking services to small companies. Hopefully, in the next few years, the improvement in the economy will become more broad based helping America's smaller companies. If these small companies see significant improvements in their businesses they will likely need more of the services that FBR provides. We see this trend as a likely catalyst for FBR in the coming years.
Inter Parfums Inc. (IPAR)
Inter Parfums has a $886 million market capitalization and it distributes, manufactures, and markets licensed fragrances under name brands such as Burberry, Jimmy Choo, Lanvin, and S.T. Dupont. With a large net cash position of $280 million, Inter Parfums has a solid balance sheet. Furthermore, Inter Parfums is cheap based on valuation ratios such as a TTM PE ratio of 6.8 and an EV/EBITDA ratio of 6.26. Also, Inter Parfums has a reasonable dividend yield of 1.7%.
We believe that the main reason that Inter Parfums is so cheap is that Burberry is buying back its license from Inter Parfums and this will cause a significant drop in revenue for Inter Parfums this year. However, we believe that given the nature of the fragrance business where industry sales are driven by either new product launches or by acquiring licenses to produce popular fragrances, Inter Parfums is in a good position to grow. With a cash horde of $280 million, Inter Parfums can buy new licenses for fragrances or develop its own new fragrances in order to grow revenues. In our opinion, the market is undervaluing Inter Parfums' grow potential.
Silicon Motion Technology Corp (SIMO)
Silicon Motion is a fabless semiconductor firm that develops, designs, and markets a broad range of high-performance, low-power semiconductor solutions used by the consumer electronics industry. Silicon Motion's primary customer is Samsung which it supplies with eMMC flash controllers and some LTE transceivers. The eMMC controller business is solid and should continue to grow. There has been some speculation that Samsung would start making eMMC controllers in-house but we believe that this would not be cost effective for Samsung. The LTE business, however, is going through a transition to an improved technology and it is unclear if Silicon Motion can regain its market share for these devices. In our opinion, the market's fears are overblown concerning Silicon Motion's overall business and this has caused a significant undervaluation of Silicon Motion's shares.
Our interest in Silicon Motion is primarily that Silicon Motion is a stable business that is selling at a very low price based on both balance sheet and valuation ratio methodologies. Silicon Motion has a market capitalization of $381 million with $166 million in cash and no debt. Valuation ratios are cheap with a TTM PE ratio of 9.88 and a forward (2014) PE ratio of 8.54. Other metrics of interest are that Silicon Motion has a PEG ratio of 0.43 and an EV/EBITDA ratio of 4.11. With such a cheap valuation, we believe that the market will soon recognize Silicon Motion's true value. Also, due to a low valuation, a firm such as Samsung may acquire the company to gain exclusive access to a critical parts supplier.
Nature's Sunshine (NATR)
Nature's Sunshine is a multi-level marketing MLM firm very similar to USANA Health Sciences (USNA) and Herbalife (HLF). About half of Nature's Sunshine's revenues come from sales of herbal remedies with the balance of revenues coming from the sale of supplements, vitamins, and minerals. Most of these MLM companies have seen depressed share prices since Bill Ackman's public criticism of Herbalife's business model. His criticisms and his short position in the shares have negatively affected the investment community's attitude toward most MLM based companies. We believe that this may be an opportunity for investors to acquire shares in a small, relatively fast growing company at an attractive valuation.
Nature's Sunshine has a market capitalization of $228 million and a net cash position of $76 million. Also, Nature's Sunshine is cheap based on a TTM PE ratio of 9.69, a forward (2014) PE ratio of 9.08, and an EV/EBITDA ratio of 4.01. In our opinion, the market's attitude towards MLM companies will improve over time and companies such as Nature's Sunshine should benefit from this change in attitude. Furthermore, we believe that Nature's Sunshine has a good business that is poised to grow. We believe that an investment in Nature's Sunshine may be much like an investment in USANA Health Sciences in its early years. By getting in on the ground floor, so to speak, with Nature's Sunshine we may experience similar gains as those achieved by USANA Heath Science's early investors.
Disclaimer: Ulfberht Capital is not an investment advisor. This article is not a recommendation to buy or sell securities. Always consult your investment advisor before making any investment decision.