Cinderellas Abound In Hoops ... And The Market

by: John P. Reese

March Madness is upon us and the big question on every college basketball fan's mind is, who will play Cinderella in this year's NCAA tournament? Every year, smaller schools and other unheralded teams push the country's basketball powerhouses to the limit during the tournament, with some successfully playing David to the big guys' Goliath. Last year two big Cinderellas -- Butler University and Virginia Commonwealth University -- made it to the Final Four of the prestigious tournament, with both schools making runs that were as remarkable as they were unexpected. This year, Ohio University is crashing the dance, making it to the Sweet 16 as a 13th seed.

Just as you can find Cinderellas each year in the college basketball tourney, so too can you find them in the stock market. While giant blue chips and popular, flashy tech stocks usually get all the attention, plenty of smaller, lesser-known companies lie hidden in the market. Just as with March Madness' Cinderellas, some of these stocks will end up fitting into that glass slipper.

With that in mind, I recently used my Guru Strategies -- each of which is based on the approach of a different investing great -- to see if I could find some of the market's potential Cinderellas. I looked for companies with market caps below $500 million, and which are not household names among investors. I found a number of stocks that fit the bill. Here's a look at some of the best of the bunch, the types of little guys that could come out of nowhere and put up some big results. Keep in mind that as smaller, lesser-known stocks, they're likely to be more volatile than larger stocks.

Body Central Corp. (OTCQB:BODY): This Florida-based retailer sells young women's apparel. It has about 220 stores located across 24 states in the South, Mid-Atlantic and Midwest of the U.S.

Body Central has a market cap of about $440 million, and gets approval from my James O'Shaughnessy-based growth model. It looks for firms that have upped earnings per share in each year of the past five-year period, which Body Central has done. The model also looks for a key combination of variables: a high relative strength, which is a sign the market is embracing the stock, and a low price/sales ratio, which is a sign it hasn't gotten too pricey. Body Central has a 12-month relative strength of 94, and its P/S ratio of 1.46 comes in below this model's 1.5 upper limit.

Kadant Inc. (NYSE:KAI): Massachusetts-based Kadant is a supplier to the global pulp and paper industry. Its products are also used in other process industries, and it makes agricultural and lawn and garden products from paper-making byproducts. It has offices across 16 countries.

Kadant ($275 million market cap) gets strong interest from the model I base on the writings of hedge fund guru Joel Greenblatt. Greenblatt's approach is a remarkably simple one that looks at just two variables: earnings yield and return on capital. My Greenblatt-inspired model likes Kadant's 16.0% earnings yield and 43.7% ROC, which combine to make the stock the 29th best in the entire U.S. market right now, according to this approach.

Hi-Tech Pharmacal Co. (NASDAQ:HITK): I wrote about this three-decade-old specialty pharma firm about six months ago, and since then it has jumped about 20%. It focuses on difficult-to-manufacture liquid and semi-solid dosage forms, and manufactures a range of sterile ophthalmic, otic and inhalation products. It's also a leader in over-the-counter and nutritional products targeted at diabetics.

Amityville, N.Y.-based Hi-Tech ($468 million market cap) still gets high marks from my models. My Greenblatt-based model likes its 18.4% earnings yield and 51.5% return on capital. The model I base on the approach of Motley Fool creators Tom and David Gardner likes its 23.2% profit margins, its tiny 0.78% long-term debt/equity ratio; and its combination of hot (relative strength of 96) but cheap (0.18 P/E-to-growth ratio) shares.

Quaker Chemical Corporation (NYSE:KWR): This Conshohocken, Pa.-based chemical firm serves a variety of industries, including steel, aluminum, automotive, mining, aerospace, tube and pipe, coatings, and construction materials. Its products and services are designed to enhance customers' processes, improve their product quality, and lower their costs.

Quaker has a market cap just below $500 million, and gets approval from the model I base on the writings of mutual fund legend Peter Lynch. The Lynch strategy considers Quaker a "fast-grower" -- Lynch's favorite type of investment -- thanks to its impressive 31.8% long-term EPS growth rate. (I use an average of the three-, four-, and five-year EPS figures to determine a long-term rate.) Lynch famously used the P/E/Growth ratio to find bargain-priced growth stocks, and when we divide Quaker's 11.1 price/earnings ratio by that long-term growth rate, we get a P/E/G of just 0.35. That falls into this model's best-case category (below 0.5).

Lynch also liked conservatively financed firms, and this model targets companies with debt/equity ratios less than 80%. Quaker's D/E is 19%, another good sign.

Alamo Group (NYSE:ALG): This Seguin, Tex.-based firm makes equipment used in agriculture and right-of-way maintenance, including tractor- and truck-mounted mowing and other vegetation maintenance equipment, agricultural attachments, excavators, street sweepers, vacuum trucks, snow removal equipment, and pothole patchers. It operates primarily in the U.S., U.K., France, Canada, and Australia.

Alamo ($330 million market cap) gets approval from the model I base on the writings of Benjamin Graham, who was known as the "Father of Value Investing" -- and Warren Buffett's mentor. A few reasons why it passes this conservative value strategy: Alamo has a current ratio of 3.7, about seven times as much net current assets as long-term debt, and it trades for 13.3 times average three-year earnings and 1.3 times book value.

Alamo also gets approval from my Lynch-based model, which likes the stock's stellar 24.6% long-term growth rate and 10.3 P/E, which make for a 0.42 PEG ratio. It also likes that Alamo is conservatively financed, with a debt/equity ratio of about 12.5%.

Disclosure: I am long HITK, OTCQB:BODY.

About this article:

Problem with this article? Please tell us. Disagree with this article? .