This Unknown Small Cap Could be a Breakout Stock in 2013

Value investors look for stocks thatoffer low risk. The idea is to buy a stock at a price level that should be near a low as measured by the fundamentals. Some value investors look for stocks with sound business models that are selling at a low price-to-earnings (P/E ) ratio, for example.

There are a number of other factors that they can screen for and many long-term investors have found success with this model. From a trader's perspective, the idea of buying and waiting usually seems unappealing because it often means having to hold stocks that don't perform well for years.

In order to be successful, value investors need to be patient. An undervalued stock might remain undervalued for some time, andwill usually only go up in price when other investors discover the stock. It might take years for other investors tospot a company, and ideally, avalue stock offers adividend that allows investors to get paid while waiting for others to recognize the value they found.

Schweitzer-Mauduit International ( SWM ) is an example of a value stock that could be recognized soon. Schweitzer-Mauduit is a largely unknown small cap, which has been in the paper business for 450 years and has solid growth prospects for the future.

Schweitzer-Mauduit is the world's largest producer of the papers used by cigarette manufacturers and controls 36% of themarket among cigarette manufacturers located outside of China. Tobacco is a slow-growing industry, but Schweitzer-Mauduit holdpatents on Lower Ignition Propensity (LIP) paper, which is becoming more widely used in the industry and increasingly required by regulators around the world.

The company's products can also be used outside the tobacco industry as well. The company's website points out, "Amazingly, the commercial applications for engineered paper just seem to grow." Among the new uses for its products is battery separator paper.

Revenue in the past 12 months totaled $821 million andearnings per share ( EPS ) reached $3.45. Schweitzer-Mauduit is a value stock with a P/E ratio of 11 and is expected to grow itsEPS at an average rate of about 15% a year for the next five years. The company also pays a dividend of 60 cents per year, an amount that is only 17% of its EPS. Dividend-paying companies are currently using an average of about 30% of theirearnings to pay dividends and the long-term averagepayout ratio is more than 50%. This means Schweitzer-Mauduit could raise its dividend significantly in the future, a possibility that might be attractive to value investors.

The monthly chart shows the potential this stock offers. A basing pattern has formed over the past two years and offers aprice target that is more than 30% above the current price. Schweitzer-Mauduit has moved above resistance in the past month, and thestochastics indicator isbullish but far from overbought indicating that this breakout could accelerate.

Earnings are scheduled to be released at the end of January, and that could be the news that attracts attention to this stock. Traders might want to take advantage of that possibility by using March $37.50call options, which are trading near $2.05. These options would be profitable if Schweitzer-Mauduit reaches $39.55, a price that would be about 10 times next year's expected earnings. Given a good earnings report, I think Schweitzer-Mauduit could reach about $43 early next year, where it would again be priced at about 11 times next year's earnings.

Value investors often use the end of a quarter or the end of the year to rebalance their portfolios. Schweitzer-Mauduit's lowdividend payout ratio could be a factor that gets noticed on value screens, and the low valuations combined with strong growth prospects could make it a buy for value investors. Traders can take positions that benefit from that possibility with a short-term options trade.

Action to Take --> Buy Schweitzer-Mauduit March 37.50 Calls at $2.25 or less. Set stop-loss at $1. Set initial price target at $3 for a potential 33% gain in three months.

This article originally appeared on

This Unknown Small Cap Could be a Breakout Star in 2013

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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