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Finding The Diamonds In The Rough On The OTC BB

|Includes: Creative Learning Corporation (CLCN), ISDR, OTCM, REPR, WFCF

I like to research small cap stocks. More specifically nano cap stocks, which Investopedia defines as companies with markets capitalizations below $50 million. There are a number of nano cap stocks in the OTC markets, most of them are garbage. The trick is to find the diamonds in the rough. I'm not looking for a stock I can flip next week, but a longer term investment. A company that will have high growth over the next 3 to 5 years or more.

What I look for are the following criteria in an initial 20 second screen:

- Profitable in latest fiscal year

- A trend of increasing revenue

- A trend of increasing shareholder equity

- Not a bank

Looking at the OTC Markets stock screener there are 9,982 securities (not including Grey markets). To make the list more manageable we will focus on common shares of U.S. companies traded on OTCQX or OTCQB, therefore excluding OTC Pink and ensuring companies have filed financial statements in a timely manner. This gets the list down to 2,397. A second criteria in the screen will be companies that are priced at least $0.20. This brings the list to 1,223.

Unfortunately the screener does not yet have the functionality to search by financial metrics. I've been told by OTC Markets that this is on the to-do list but not a high priority. If you click on a company name, you can usually see the quarterly and annual financial statements. This is a long process to go through every company on the list of 1,223.

Unfortunately the screener does not yet have the functionality to search by financial metrics. I've been told by OTC Markets that this is on the to-do list but not a high priority. If you click on a company name, you can usually see the quarterly and annual financial statements. This is a long process to go through every company on the list of 1,223.

One way to narrow it down is to select a minimum trading volume, such as at least 5000 shares. This narrowed it down to 381. However this is not an average volume, but rather the volume for that day. It doesn't bother me if a stock doesn't trade every day, as long as it trades fairly regularly, namely at least once a week.

Instead of $0.20, we can raise the bar to $1.00/share. This will lower the universe to 783. Using $1 and minimum 5000 shares traded gets it down to 124. This is more manageable to go through, however may exclude some companies that meet the initial criteria.

I have identified the following five companies as meeting my initial criteria.

There may be others out there that I haven't stumbled across. I've only been through a few hundred after all.

 

 

Company Symbol Market Cap ($M) Share Price Trailing P/E Average Daily Volume 3 Year Revenue Growth
Creative Learning CLCN 7 $0.58 14.5 4,000 8,892%
Issuer Direct ISDR 12 $6.10 21.6 2,600 128%
OTC Markets OTCM 87 $8.15 16.3 2,000 38%
Repro REPR 8 $0.21 10.5 41,900 106%
Where Food Comes From WFCF 30 $1.40 77.8 28,800 98%

Source: Yahoo Finance for everything except 3 Year Revenue Growth, which are my calculations based on financial statements.

I know OTCM is not technically a nano cap, but still a small firm listed on OTC BB.

Once a company meets the initial criteria, it then has to be trading at a reasonable valuation. I would like to see a P/E of 20 or less. If I'm investing in a very small company, to compensate for the risk, I want some kind of downside protection. I also want growth. I would like to see top line growth of at least 20%/year and projected growth to be at least that level as well. A dividend yield is an added bonus, but not expected with a very small, fast growing company. Note that both ISDR and OTCM pay a dividend.

Looking at this list, there are two companies from the list of five that fit the above growth and P/E criteria: CLCN and REPR.

Digging deeper, CLCN actually started in 2009, and only did $38K in sales, which makes it a low base to grow from. That being said, revenue increased by 117% in fiscal 2012 from the previous year and the company is on pace to grow revenue by another 35-45% this year. Last year was the first year the company made any meaningful profit. The company sells franchises called Bricks 4 Kidz that offer educational programs designed to teach principles of engineering, architecture and physics to children using LEGO. There are now over 320 franchises in 39 states and 14 countries. In this overly digital world that we live in, I like the idea of teaching kids principles by using physical plastic bricks for the them to build with their hands. The company is fairly unique in this category, which provides an opportunity for much further expansion.

REPR designs, manufactures and markets proprietary medical devices. They have a syringe infusion system and an emergency airway suction system that they offer to the health care industry. The company has been around for over 30 years, but has remained quite small. Revenue has increased every year over the past five years, while net income has generally been flat. Net profit margins have decreased each year, as has ROE. Given a P/E of 10.5, it is currently hard to see much downside however the company has yet to prove it can increase earnings. To me, CLCN looks like a more attractive investment.

Based on a 12 month trailing P/E, ISDR is a little too rich for me. However this company is providing innovative solutions using cloud based compliance technologies for mainly smaller companies. ISDR generates a lot of recurring revenue and reported net income of $0.11/share for Q1 2013. If we assume $0.44/share for the year, this puts the forward P/E at 13.9. While I think this scenario may be realized, earnings have historically been choppy as the firm continues to grow. If the firm continues to execute and the stock price increases at a slower rate, there may be an attractive entry point.

Disclosure: I currently own CLCN and do not plan on selling within the next 90 days.