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Summary

  • Small cap stocks are often overlooked by investors when markets are at all-time or multi-year highs.
  • I believe that there are still undervalued/fairly priced small caps available that will make nice long term investments.
  • Out of this group of aluminum and steel stocks, I feel that Kaiser Aluminum is currently the best option for long term investors.

Overview

With the stock market near an all time high, I have noticed that several investors are steering clear of small cap stocks. While small caps in general, do perform worse than their large cap counterparts during bear markets, I do not think that is a good enough reason by itself to avoid all small cap stocks as possible investments.

One reason I believe this, is that no one knows just how high this market is going to climb, so expecting a correction in the near future, doesn't necessarily mean that one is going to occur. But even if a correction does occur, it doesn't mean that all small caps will perform badly. When looking at long term investments, current valuation and future outlook is more important than the market cap of a stock.

In April/May I wrote a series of articles that ranked the Dividend Champions based on a variety of metrics. Part 1 of that article can be found here. Using a similar method, I will be ranking stocks of the S&P SmallCap 600 index in this series of articles. I will be using the following 10 metrics to gauge each stock by:

  • Revenue Growth (past ten years)
  • Earnings Growth (past ten years)
  • Price Returns (past ten years)
  • Return on Assets (trailing twelve months)
  • Return on Equity (trailing twelve months)
  • Return on Invested Capital (trailing twelve months)
  • Price to Free Cash Flow (trailing twelve months)
  • Debt to Equity Ratio (annual)
  • PE ratio (trailing)
  • PE ratio (forward)

The scoring system is simple. If there are 8 stocks in the industry being reviewed, then each metric will have a score between 1-8, with the best performing stock receiving an 8 and the worst performing stock receiving a 1.

For this first article, I will be taking a look at the Aluminum and Steel industries within the Basic Materials sector. Six stocks will be reviewed, so each metric will have available scores of 1 through 6.

The six stocks are:

  • AK Steel (NYSE:AKS)
  • Century Aluminum (NASDAQ:CENX)
  • Gibralter Industries (NASDAQ:ROCK)
  • Kaiser Aluminum (NASDAQ:KALU)
  • Olympic Steel (NASDAQ:ZEUS)
  • Suncoke Energy (NYSE:SXC)

AK STEEL

ValueScore
Revenue Growth (past ten years)25.09%3
Earnings Growth (past ten years)-156%2
Price Returns (past ten years)45.92%5
Return on Assets (trailing twelve months)-3.29%2
Return on Equity (trailing twelve months)26.59%6
Return on Invested Capital (trailing twelve months)-8.31%1
Price to Free Cash Flow (trailing twelve months)16.94x5
Debt to Equity Ratio (annual)-6.82x1
PE Ratio (trailing)NA1
PE Ratio (forward)636.00x1

Looking at the table above, you can see that AK Steel scored a combined total of 27. While the company has seen decent price returns over the past ten years and has a decent return on equity, AK Steel has seen earnings decline significantly during this time, which has help lead to its negative debt to equity ratio.

Because both AK Steel and Century Aluminum do not have an available trailing PE ratio due to negative earnings, I gave both stocks a low score of 1.

CENTURY ALUMINUM

ValueScore
Revenue Growth (past ten years)72.06%5
Earnings Growth (past ten years)-1.17K%1
Price Returns (past ten years)-35.50%1
Return on Assets (trailing twelve months)-4.06%1
Return on Equity (trailing twelve months)-7.52%1
Return on Invested Capital (trailing twelve months)-5.95%2
Price to Free Cash Flow (trailing twelve months)81.61x2
Debt to Equity Ratio (annual)0.25x6
PE Ratio (trailing)N/A1
PE Ratio (forward)21.04x3

Looking at the table above, you can see that Century Aluminum scored a combined total of 23. The company has seen stable revenue growth along with low debt, but Century Aluminum has seen earnings plummet. With negative price returns and along with negative returns on assets and equity, its easy to see why this company had the lowest combined score out of this group of stocks.

GIBRALTER INDUSTRIES

ValueScore
Revenue Growth (past ten years)-2.98%1
Earnings Growth (past ten years)-109%3
Price Returns (past ten years)-20.30%2
Return on Assets (trailing twelve months)-0.45%3
Return on Equity (trailing twelve months)-0.86%2
Return on Invested Capital (trailing twelve months)-0.59%3
Price to Free Cash Flow (trailing twelve months)12.09x6
Debt to Equity Ratio (annual)0.45x4
PE Ratio (trailing)59.04x4
PE Ratio (forward)19.66x4

Looking at the table above, you can see that Gibralter Industries scored a combined total of 32. The company has some pretty good balance sheet numbers, but with negative revenue, earnings, and price growth along with negative returns on assets and equity, it's difficult to make a good case for investing in this stock long term.

KAISER ALUMINUM

ValueScore
Revenue Growth (past ten years)51.43%4
Earnings Growth (past ten years)166.90%6
Price Returns (past ten years)104.20%6
Return on Assets (trailing twelve months)4.93%6
Return on Equity (trailing twelve months)8.03%5
Return on Invested Capital (trailing twelve months)5.92%6
Price to Free Cash Flow (trailing twelve months)24.12x4
Debt to Equity Ratio (annual)0.36x5
PE Ratio (trailing)15.54x6
PE Ratio (forward)19.61x5

Looking at the table above, you can see that Kaiser Aluminum scored a combined total of 53. Kaiser Aluminum scored the highest out of this group of stocks (with the #1 or #2 highest score in eight out of the ten metrics). Besides being the only stock to have seen positive growth in all three long term metrics (revenue, earnings, and stock price), the company is one of the more fairly priced stocks in this group.

OLYMPIC STEEL

ValueScore
Revenue Growth (past ten years)94.50%6
Earnings Growth (past ten years)-82.90%5
Price Returns (past ten years)44.62%4
Return on Assets (trailing twelve months)0.75%5
Return on Equity (trailing twelve months)1.76%3
Return on Invested Capital (trailing twelve months)1.02%4.5
Price to Free Cash Flow (trailing twelve months)32.15x3
Debt to Equity Ratio (annual)0.67x3
PE Ratio (trailing)50.67x5
PE Ratio (forward)17.45x6

Looking at the table above, you can see that Olympic Steel scored a combined total of 44.50. The company has seen the highest revenue growth out of this group of stocks, but has struggled with earnings growth. Because both Olympic Steel and Suncoke Energy have the same return on invested capital value, I gave them both a 4.5 (based on ranking compared to other stocks).

SUNCOKE ENERGY

Has only been around since 2011

ValueScore
Revenue Growth (past ten years)17.11%2
Earnings Growth (past ten years)-83.10%4
Price Returns (past ten years)19.18%3
Return on Assets (trailing twelve months)0.69%4
Return on Equity (trailing twelve months)2.77%4
Return on Invested Capital (trailing twelve months)1.02%4.5
Price to Free Cash Flow (trailing twelve months)280.08x1
Debt to Equity Ratio (annual)1.24x2
PE Ratio (trailing)93.50x3
PE Ratio (forward)112.56x2

Looking at the table above, you can see that Suncoke Energy scored a combined total of 29.50. The company has poor earnings history and a high valuation based on both trailing and forward PE ratios.

Conclusion

Kaiser Aluminum scored the highest with a value of 53, nearly 10 points higher than the next highest stock. In addition to having the highest earnings growth, price returns, return on assets, and return on invested capital, Kaiser Aluminum also is one of only two stocks that pay a dividend. It's yield of nearly 2% is significantly higher than Olympic Steel's yield of less than 0.50%.

In the company's latest quarterly report, the CEO stated "We remain bullish about Kaiser's long-term prospects and our ability to drive shareholder value through a combination of growth and returning cash to shareholders in the form of dividends and share repurchases." This is a sentiment I agree with. I believe the company is positioning itself nicely through lower expenses and improved manufacturing efficiencies to be able to nicely reward long term shareholders.

Because of these factors, Kaiser Aluminum is my top choice for outstanding small cap out of this group of stocks. As always, I suggest individual investors perform their own research before making any investment decisions.

Source: Outstanding Small Caps, Part 1: Kaiser Aluminum