Three Smallcap Stock Picks

On December 24, The Wall Street Transcript interviewed R. Brent Byrne, President and CEO of Divi-Vest Advisors, Inc. Key excerpts, including his smallcap picks, follow:

TWST: When you look at Traffix (TRFX) and other small cap companies, is it different from looking at larger caps? Are you looking for anything different in their valuations or in debt mode?

Mr. Byrne: Well, yes. Debt becomes a much bigger issue with small caps versus large cap. In the case of Traffix, they have no debt and plenty of cash. They are set to merge, so the ongoing entity will have different fundamental factors than Traffix today. The interesting part of Traffix is the vertical efficiencies between Traffix and the new company, New Motion. It seems like a great marriage. As we all know, the mobile handset market is taking over everything else in consumer technology, and here is a company that seems to be taking advantage of that development.

TWST: Do you have another smaller cap or mid-cap name you can tell us about?

Mr. Byrne: Another stock we like at the current quote is Furniture Brands (FBN), one of the nation's leading manufacturers of home furnishings. FBN presents an interesting opportunity, one that should bounce back once a little life is breathed back into the consumer mindset. At the current quote of over $10, Furniture Brands trades at an approximate 40% discount to book value and yields about 5.7%. It appears that two groups of activist type investors are buying up the stock in addition to an assortment of insiders. While the current retail sales environment for home furnishing is weak, Furniture Brands should trade higher with the return of any uplift in consumer spending later in 2008. If the Fed brings back the overnight lending rate to the 3% level, this should benefit the consumer. We know that Americans like nothing more than to spend money. As soon as they sense the all-clear signal, consumer discretionary stocks should come into play. We believe Furniture Brands is a well-run company that suffered with the pullback in consumer spending and the degradation of real estate in this country. As things start to heal economically, this brand of stock should bounce back.

Another stock in the small cap space that we like at this level is StarTek (SRT). StarTek is an interesting small cap that deserves some consideration at the current depressed price, under $10 a share. StarTek operates customer call centers for big telecom and cable companies. As the complexity of gadgets and services expand, more customer interface will be needed. This presents an opportunity for StarTek in that demand for such services appears to outstrip available supply. StarTek has very little debt to speak of and around $3 per share in cash. We like the stock quite a bit at the current quote.

Comments

[wax]

No offense, and no disrespect to Mr. Byrne, but why would anybody pay any attention to a guy whose investment philosophy is to invest in stocks that pay high dividends in order to avoid picking losers?

Buying a stock because the dividend yield happens to be high is fine, but yield is function of price, so assuming the dividend amount stays the same, the yield will go up or down depending on the price.

Let's look at the first pick, Traffix, Inc. (Nasdaq: TRFX). The company lists itself as an internet media and marketing company that provides end-to-end marketing solutions for its clients. I have to tell you, when I visited the company's website that I came away with the impression that if this company went out of business, at least half of the spam I get would stop.

At any rate, I did look at the company's latest annual financials which were for the period ending 11/06 and I have to say I personally wasn't very impressed.

The company's direct costs are 63% of sales, and their selling and administrative expenses are 30% of sales. Taxes eat up another 2% of sales, and dividends consume another 6% of sales, leaving absolutely nothing for a rainy day.

NOTE: Please do not freak out, the reason it doesn't total 100% is because of rounding.

On a value investing basis, I estimate that a reasonable value for the stock is $7, with a buy target of $3.50, a first sell target of $6.75, and a close target of $7.50.

On a fundamental investing basis based on the latest 10-K filing of 11/06, the stock has a PE of 35, a Return on Invested Capital of 10%, Free Cash Flow of $0.23, a Tangible Book of $2.36, and pays a cash dividend of $0.01 per share.

On a short term investing basis, based on a recent close of $6.11, the stock has overhead resistance at $7.39, a 28% increase from current levels, first support at $6.05, a 1% decline from current levels, and second support at $5.71, a 7% decline from current levels.

So all of this brings me back to the company's investment philosophy, investing in stocks that pay high dividends to avoid investing in losers.

Now admittedly I'm not the sharpest pencil in the box, but it just seems to me that if the one penny per share dividend that Traffix, Inc. pays is considered a high paying dividend by Mr. Byrne, it might just be that his client base dies off before they are able to determine how well his investing philosophy actually works.

Wax