Valuations Getting Big? Look At Small Caps In 2018

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By SA Marketplace :

2017 has been an exciting year in the markets. All-time highs seem to fall every week, the market has shaken off three Federal Reserve rate hikes as no big deal, and there is so much bitcoin to talk about that it makes a head spin.

It's also been an exciting year on the Seeking Alpha Marketplace. Marketplace is our platform for authors to offer investing services that go beyond what they can do in public articles. In 2017, we went from 75 authors on the platform to 157. Those authors have a wide range of expertise and backgrounds. And while 2017 has felt like a year where everything has gone in one direction - up - we wanted to draw on this diverse array of backgrounds.

So, we're doing a Year End Marketplace Roundtable series. Over the next 2 weeks or so, we will be featuring expert panels giving their outlook on 2018 in corners of the market ranging from Tech to Energy, Dividends to Alternative Strategies, Gold to Value investing. We hope you'll find these discussions useful no matter how you invest.

Today's roundtable looks at small caps, which noticeably lagged

Our panel:

Editors' Note - questions were sent out on November 30th and answered in early to mid December, as the U.S. tax reform bill was still pending.

Seeking Alpha: Tax reform has been a big theme for small-caps who are perceived to benefit more than big companies. However that issue plays out, how do you view the market climate for small-cap stocks?

Ruerd Heeg : For international deep value small caps, it will not matter as much as for US companies. Of course, a rising stock market helps. But in the end, specific developments with these companies or within the sector they operate determine most of my investment results. International small caps got more expensive last year, especially in Japan. But there are still many Japanese deep value stocks. And there is always somewhere a new crisis depressing stock prices and generating new opportunities for deep value investors.

Howard Jay Klein : Small-cap stocks should see an upside largely related to likely free cash flow increases that clearly will be diverted to expansion of their business base to such things as scaled acquisitions of related companies, scaled up existing businesses and above all, implementation of technologies heretofore laying outside of sensible affordability for small-cap stocks.

James Sands : Small-cap stock indices have lagged the Dow, S&P, and NASDAQ this year. I expect with a tax bill in place, that economic growth will accelerate. Small-cap stocks are potentially set up to see very strong gains in this environment and could see stronger results over the next year or so.

Darren McCammon : Tax reform does benefit small caps disproportionately as they were not previously as able to take advantage of overseas tax strategies. However, since the concerted effort to push tax reform started gaining traction at the beginning of April, even within the small cap space, there have been winners and losers. Since that time, the Russell 2000 has gained 13%, while those seen as losers have not done so well. Pass-through securities as a whole (REITs, MLPs, BDCs) are down 2, with MLPs down a whopping 17.5%. Going forward, the greater opportunity may be in these beaten down "losers" who after all do also get some benefits from the new legislation. Namely:

1. Establish a top marginal tax rate of 25% on limited partner's business income, or allow 23% of pass-through income to be deducted against other taxable income (House vs. Senate version)

2. Allow new businesses' capital investments (excluding structures) to be immediately expensed

Dining Stocks Online : It doesn't seem like one can really paint an entire subset of the market with a broad brush like that. It comes down to execution on the individual company level.

Donovan Jones : I focus on IPOs, which are predominantly comprised of fast-growing companies with relatively low taxable income, if any. These are companies attempting to disrupt legacy incumbents so won't be affected by tax policies in the near term after they go public.

Lutz Muller : The top line of most small caps is totally driven by consumer demand generated in the United States. This, in turn, is significantly impacted by consumer confidence levels. These portend well for next year. At this point, the index is at its highest since the year 2000. Short of major disasters, such as a war, the outlook continues to be excellent.

The Investment Doctor : Whilst European Small-Cap Ideas mainly focuses on European companies, you do bring up a valid point. Even in Europe, the tax laws continue to change, and sometimes, they improve. For instance, the Dutch government plans to abolish the Dutch dividend withholding tax (15%) in 2019 which would immediately increase the net dividend income for investors, whilst the Belgian government is gradually reducing the corporate tax rate from 33.99% to 25%, which will also have a major impact on the bottom line of companies and boost the net income by a double-digit percentage!

Safety in Value : I'm more of a bottom-up stock-picker than a macro forecaster, and I strongly think it's always a good time for small and micro-cap stocks, simply because there will always be some sector or stock that the market holds out of favour. Right now, there are certain insurance segments out of favour, and many old-economy businesses aren't participating in the FAANG led rally. That leaves them well positioned going forward with undemanding valuations.

SA: Have you employed any new techniques for finding small-caps this year, and if so, what's been working? In other words, we're in year 9 of a bull market, small caps are becoming mid caps, and the remaining small caps are more picked over than ever; are you able to find fresh opportunities amidst all this?

RH : This year, I have greatly improved my stock selection. I made it more systematic by simultaneously ranking stocks on many value metrics and liquidity. Now, my stock selections are much more in line with scientific research on returns of net-nets and low EV/EBIT stocks. These rankings also allow me to compare the metrics of many more stocks, and more objectively. That has uncovered many new deep value stocks. It is too early to tell how this works in practice, but initial results are fabulous. See also my article , "Use your extraordinary edge with these 2 investment strategies".

HJK : Yes. I search for companies lodged in the tricky space well past start ups but decidedly nowhere near potential scale-ups whose growth has been inhibited by lack of capital for rapid expansion of their business models.

JS : There are definitely opportunities within transports and different commodity-based industries. I tend to look for companies offering discounted valuations based on special situations and/or cycles. I also like to focus on more mature small-caps, on their way to mid-cap status. A recent example has been the energy/freight recession from the summer of 2014 to March/April 2016. Despite continued overall economic expansion, there were many excellent small-cap opportunities, especially during late 2015/early 2016.

DM : In theory and all else being equal, I prefer companies in the $75 million - $200 million market cap range because as they grow, they can get picked up by index funds, ETFs, and Wall Street analysts. With small caps, hidden value which eventually turns into known growth can be very rewarding. It in effect can act as a price accelerator which turning successful research cases like Eldorado ( ERI ) or RCI Hospitality ( RICK ) into multi-baggers. However, you are correct that finding these securities has become more difficult in the last few years and requires a lot of research effort.

I generally focus on the same kinds of things Wall Street pays attention to:

  1. Valuation, effectiveness, and risk ratios
  2. Cash flow and management allocation of capital
  3. Important refinances and debt reductions
  4. Understandable and repeatable growth
  5. Good margins with moats to maintain them; etc.

The difference is because I am an individual, I can apply these same research techniques to equities Wall Street can't: small and micro-caps, obscure thinly traded equities no one even knows exist, etc.

An example would be KTP. KTP is a J.C. Penney ( JCP ) bond, put in a $25 par trust wrapper, and then sold in the regular market under symbol KTP. It trades less than 32k shares per day, so most funds and Wall Street firms wouldn't think of owning or covering it. This is an advantage for the individual investor, as we can now pick up KTP at about 50¢ on the dollar with a 15% simple yield. We wouldn't get this kind of opportunity where the security is not obscure.

Bram de Haas : Most of my U.S. exposure is still through small caps, but I've been looking increasingly overseas and even in emerging markets to find really interesting companies.

DJ : The IPO 'window' has been open as the overall market has risen and volatility has generally been low. For IPOs, 2017 has proven itself a reasonably busy year, but with fewer, higher quality IPOs and a few notable flameouts. Over the past several years, there have always fresh opportunities in the U.S. IPO market, even during periods of overall market doldrums; biopharmaceutical firms continue to dominate the IPO market and they have tended to go public whether the market is generally open or closed to other industries.

The Value Pendulum : Start with the A's and simply turning over more rocks (stocks), as Buffett recommends, is an evergreen stock idea generation strategy that has continued to work for me. While more small-caps have migrated to the mid-cap and large-cap categories in tandem with the overall stock market's rise, there is also an increasing number of micro-caps graduating to the small-cap category and becoming more liquid and investable. Furthermore, small-caps outside the U.S., particularly in Asia, offer tremendous value compared to their U.S. counterparts. While the U.S. market continues to set record highs, the Asian stock markets are relatively undervalued. The MSCI Asia ex-Japan (MXASJ) Index was valued at approximately 1.75x P/B as of end-November 2017, compared with 3x P/B at its peak in 2007 and 1.19-1.23x P/B at its 2001, 2003 & 2009 troughs. In contrast, the U.S. market's Q-ratio (similar to P/B ratio) was 1.22x as of end-November 2017, more than double that of its 2009 trough of 0.54x, according to research by Advisor Perspectives. Also, research by Allianz Global Investors also shows that a strategy of investing in global small-caps has "never lost money and has always outperformed global large caps" over every 10-year rolling period between end-1994 and end-2015.

LM : I watch out for closely held small caps likely to go public and jump in once the filing is complete.

TID : Absolutely. Especially in Europe, analyst coverage of true small cap companies is very limited (and usually non-existent at all). With a specific focus on free cash flow results and a special love for family-owned companies (which usually are more prudent in their decision-making process compared to larger companies where the management only cares about the year-end bonuses), you can continue to find gems in Europe.

SV : Two adjustments I've made as the market valuations increase are to keep going smaller and to buy based on events. The very smallest companies in the market are often ignored and don't float up with the market but trade on their own news and financials, which makes them fertile hunting ground during a bull market. I've also significantly emphasized arbitrage and event-driven investing this year, which is largely market neutral, because returns depend on the event.

GS Analytics : We primarily do bottom-up research trying to find high quality compounding/turnaround stories, which market is ignoring or underestimating. In addition, we also make sure that valuation is still reasonable. While we are still able to find high quality stories, the number of companies which fit in our valuation criteria is decreasing. So, we expect the number of new ideas to decrease slightly. One mistake which investors make during the peak of bull market is trying to change their approach to select stocks (which they would otherwise avoid) during these times. We believe sitting on sidelines (holding cash/gold) is a better approach than being too adventurous during these times. That said, we currently have a list of four new ideas which we believe can double over the next 3-5 years. These are companies which have company/industry specific catalysts which can provide meaningful upside while limiting downside. So, yes, we are still finding opportunities but the number has decreased.

SA: What was the big story or lesson learned for you in 2017?

RH : Straight Path Communications ( STRP ) sold essentially worthless spectrum to Verizon ( VZ ) for about 3 billion USD. That story has multiple lessons. For example, be careful when speculating against certain (value) investors, in this case, Lloyd Miller III. And the obvious lesson for short sellers is there is always a bigger fool. This year saw many excessively overvalued stocks rallying even higher. I have not given up on short selling, though.

HJK : That warnings about a bubble when the Dow passed an inflection point healthily over 20,000 were clearly oblivious to improving real economy data points which supported the idea of lots of runway left to the upside.

JS : Amazon ( AMZN ) is likely to continue to impact a wide variety of different industries and companies. News can have a strong impact on any single stock in Amazon's path. But when it comes to stalwarts and industry leaders in any sector, it is Amazon is not as strong as some like to think. The Amazon fear-factor has been a great buying opportunity throughout the year.

DM : A big story for 2017 is one you indirectly alluded to with the previous question. Momentum investing, otherwise known as index investing, has propelled first mega-caps, then DGI stocks, and now Russell 2000 members forward. We tend to say we are contrarian, but obviously, many are just buying the index. Like tulip bulbs, the nifty 50, or houses, this will work, until it doesn't.

DSO : Market sentiment is crucial. Certain sectors simply are being discarded due to larger macro concerns (e.g. retail, restaurants, etc). Long term, though, the underlying profits of each firm will matter, even if the media headlines ignore them.

BH : 2017 has been a year where it's been really tough to find lots and lots of great investments. The market continued to expand the value it put on potential future cash flows. Result being that many companies seems too risky to me. What's surprising is that even though the general market is trading at elevated multiples it didn't slow down at all for the year. We did great for the year, but definitely not because of getting the market direction right.

DJ : In the IPO market, the big story was the 'invasion' of Chinese firms in the education and financial services space going public in U.S. markets. These firms have unusual legal structures and are subject to Chinese regulations, which can be capricious and destabilizing. A number of firms had significant post-IPO stock drops as a result of regulatory changes, so investors should proceed with extreme caution with any future Chinese IPOs.

LM : Particularly in the toy space, which is my specialty, innovation is the key. 50% of all toys now on the shelves did not exist a year ago - innovations are absolute key. Given this, the most successful toy companies in 2017 were also those with the most effective innovation process. Examples are Spin Master, MGA Entertainment, EOne, and Jazwares.

SV : One big lesson from 2018 was the effect of index investing on the markets, and how passive fund flows can be the force that picks winners and losers. One example is Fonar ( FONR ), the company that invented the MRI. They were added to the Russell 3000 this year, and shares appreciated from $19 to $33 on the back of that, which is a remarkable return in only a few month. The other lesson is that reducing the amount of float (by putting it in passive hands) increases volatility. Fonar reported a slower growth quarter and the shares fell to $22 when I wrote them up. They've since appreciated ~10% in the month since then, but the lesson here is that volatility is there to be taken advantage of.

GSA : American Woodmark ( AMWD ) was one of the big stories of 2017. We recommended it to our subscribers when the stock was trading at ~$77 and then published it on the free site as a top idea when it was trading at ~$86 (it won first prize in Seeking Alpha 52-week high/low contest). American Woodmark is a high quality company which has posted above market and above peer group top and bottom-line growth for the last several years. The company's balance sheet was also much stronger than peers with net cash of over $200 million. Management was looking to deploy this cash to increase growth. Despite of excellent past track record and good growth prospect, the stock was trading at discount to its peers. This valuation discrepancy corrected with recent RSI Homes acquisition. I expect the company's EPS to reach $10 over the next 3-4 years, and the stock can trade north of $200. This stock also taught me a good lesson in patience. While management had shared intent to deploy cash for organic/inorganic growth for quite some time, their acquisition announcement came at the end of the year in December. Meanwhile, the stock saw a good deal of volatility. Sometimes waiting is tough, but if you have found high quality company at right price, you have to trust their execution.

SA: What are you preparing for in 2018? Any big themes to watch out for?

RH : Recently, I have written a software producing a ranking of the best momentum stocks among low EV/EBIT stocks. This is similar to the "Trending Value" strategy described in the book "What Works on Wall Street" by James O'Shaughnessy. This strategy is one of his top performing strategies, in terms of both geometric return and Sharpe ratio. I am confident this strategy works even better when applied to international stocks. Moreover, I have improved his strategy by also using metrics for liquidity and volatility. Doing this was O'Shaughnessy's own suggestion which also has been confirmed in more recent momentum research.

HJK : I worry more about junk bond prices than anything because to me they are an under-reported harbinger of the possibilities of a bubble ahead.

JS : Consolidation in transports is my theme for 2018. XPO Logistics ( XPO ) is looking to spend around $8 billion in deals at some point. I think there may be a couple public companies which could be acquired by XPO. Inflation is another area for investors to keep an eye on. This could lead to stronger results for commodity-based businesses. Reduced taxes and more price power are going to lead to margin expansion for a lot of companies that have been struggling the past couple of years.

DM : Themes I continue to pursue for 2018 include:

  1. Booming Economy and Trade
  2. North American Natural Gas "Relief Valve Effect" (the US should become a net natural gas exporter in 2018)
  3. Turnarounds
  4. Increasing Interest Rates
  5. Shipping Lease Rate Improvements
  6. Cash Flows

DSO : How long can this momentum-driven market continue to climb higher each and every month? Will an unforeseen hiccup finally cause a correction, or will it just be good news always for another 12 months?

BH : We are in risk mitigation mode. I'm scrambling to put portfolios together with companies or ideas that will deliver value over time but do not trade in sync with the market.

DJ : A noted technology venture capitalist believes that 2018 and 2019 will represent 'bumper years' for technology IPOs. The cohort of tech 'unicorns' (valued at greater than $1 billion in private financings) that raised large sums in 2014 and 2015 may be forced to go public to provide exits for their impatient late stage shareholders.

TVP : The most significant development for small caps in 2018 is the Markets in Financial Instruments Directive (MiFID) II standard in Europe, which will take effect at the start of 2018, and lead to the gradual unbundling research and trading commissions globally across all markets over time. This is likely to shift more resources and attention to the large-caps (fund management companies with larger AUMs are the ones who can afford to pay for research and will prefer coverage of their investment universe of large-caps) and result in fewer small-caps being covered by sell-side analysts, which drives even greater inefficiencies, mispricing and investment opportunities in this space. In addition, the reversal of passive inflows into ETFs is just a question of "when" rather than "if." Small-caps should benefit from the eventual rotation and re-allocation of capital from index heavyweights into undervalued small-caps.

LM : You get your first picture of innovative toy products at Toy Fair in February 2018 in New York. I also then get inputs from the leading toy retailers which new toys they consider sufficiently promising to set aside space on their shelves. Other than that, the major question mark is the tax legislation coming down the pike. Small-caps will benefit if the proposed new tax code goes into effect. Firstly, they are mainly U.S. based and do not have access to the many loopholes that under current laws are available to the bigger players. Hence plugging these loopholes will not hurt the Small- caps and the offsetting benefits will be extremely beneficial for them

TID : I think we will see more M&A in the small-cap and mid-cap space. We have seen some mega-mergers in the past few years (SABMiller - ABInBev ( BUD ), Dollar Tree ( DLTR ) - Dollar General ( DG ), DowDuPont ( DWDP ), Disney ( DIS ) - Twenty-First Century Fox (FOX),...), but haven't seen much action in the small-cap and mid-cap sectors. As debt is becoming more expensive, we might near the end of large (cash-based) acquisitions, and larger companies could be hunting for smaller bolt-on acquisitions.

Additionally, some families might be fed up with the hassle of being listed and just take their companies private again. Companies with strong free cash flows and a strong balance sheet are prone to a management/family buyout.

SV : The big thing I'm always working on is a collection of dramatically undervalued stocks. Thematically, given how the market is, many of my ideas are trending towards companies that have high cash balances, and especially net-nets, where the net current assets of the company exceed the market capitalization. I also have rotated into a higher than usual concentration of arbitrage and special situation ideas. The big advantage of these ideas in a market due for a correction is that they continually return cash, which provides dry powder for use buying bargains in any eventual downturn.

GSA : For 2018, we are making a research library of high quality compounding ideas we would like to buy cheap if market corrects.

SA: What is one of your best ideas for 2018, and what is the story?

RH : In general, investing based on my rankings is a great way for going forward. For investing in individual stocks, I like very ugly stories with extremely cheap stocks. Based on statistics, they have the best returns. One of the cheapest stocks with an ugly story is Rosedale Hotel Holdings, ticker HKG:1189. A couple of years ago, I bought and sold it for 100% gain. In April 2016, I bought it again, below my first purchase price. Rosedale Hotel Holdings has one of the best rankings in last month's net-net list. The company trades for less than a quarter of current assets net of all liabilities. The company makes a loss, has few income-generating assets, trading is illiquid. Two years ago, there was a dilution (but not an excessive dilution), but before that the company paid high dividends. The CEO is a large shareholder. He manages multiple other deep value companies but has been involved in higher valued companies as well. There have been transactions that do not seem to make sense. But it might be possible to justify them. Despite the ugly story, this stock is great based on statistics. Such investments only work out well when buying a full, representative sample of similar ugly but extremely cheap stocks.

HJK : Consolidation of the regional gaming space in the US. I see accelerating transactions in the mop-up of small, regional operators under larger acquirers. There is an unchallengeable financial logic to this in my view, and I will be tracking these possibilities for my Marketplace subscribers in particular as I dive into possibilities and make sure they get in early on deals with big upsides that few currently see.

JS : For small-cap, I'll have to stick with Matson ( MATX ). The stock has been unduly punished from competitive fears in its Hawaii market. If the market can see economic acceleration over the next couple of years, I think Matson could break out back towards $40 per share reflecting close to 40 percent upside. Investors should also pay attention to container lessors, the unbelievable run in 2017 could push higher into 2018, especially if ocean freight rates can remain disciplined.

DM : Bri-Chem (BRYFF) ((BRY.TO)) is a drilling mud supplier which benefits from themes #2, #3, and #6 above as well as indirectly a general increase in energy prices. You can find out more about it in, " Bri-Chem: Attractive Metrics, And 45% Potential Near-Term Upside ". I think it still has more than 45% upside and would not be surprised if that happened relatively quickly.

DSO : Habit Burger Grill ( HABT ). Small-cap restaurant stocks have been even more volatile than usual, but this name has a pristine balance sheet and plenty of white space in the U.S. to keep expanding (fewer than 75 locations outside of California). The stock is trading for $9, down more than 50% from its 2017 high. It could easily rise 30-50% in 2018.

BH : Itasca Capital (ICLTF) is one of my favorite small cap companies going into 2018. It's a holding company that contains cash, warrants and bonds tied to Limbach Holdings (LMB). Limbach is a favorite idea of Dane Capital, who wrote a recent editors' pick about the company - Limbach: Materially Undervalued And Misunderstood . Through Itasca you get asymmetric exposure to Limbach. The downside is mitigated while you enjoy a lot of upside if the company does well.

DJ : Enterprise IT company Apttus, which streamlines the sales process with its Configure - Price - Quote SaaS business, has just hired an experienced CFO, which is typically a precursor to going public. I've spoken with their Chief Revenue Officer, and the firm will likely file its S-1 to go public in 1Q 2018. At IPO Edge, I will analyze its operations with an in-depth research report. I look forward to learning how well they are executing and to provide my membership with exclusive research.

TVP : 68% owned by IMAX Corp. (IMAX) in the U.S., Hong Kong-listed IMAX China ( IMXCF ) (1970 HK), a Chinese theatre screening technology company that generates revenue from selling IMAX equipment to movie theatres and sharing box office revenue with movie studios and theatres that play IMAX movies, is one of my best ideas for 2018. The Chinese cinema industry, the world's second largest, remains underpenetrated, as China's screens per million people is one-third that of the U.K. and one-fifth that of the U.S. IMAX China is the best stock to play the Chinese cinema industry growth story, as it is undervalued (under 20 times forward P/E versus mid-twenties P/E for peers), and boasts scalability (minimal investments in capital expenditures and R&D as IMAX China only licenses its technology and brand, while the parent company IMAX incurs the R&D), revenue visibility from backlog (operated 482 screens as of September 2017 and has contracted to install 350 more before 2022 or about 120 screens per annum), premium technology (dominant non-conventional theatre screening technology in China and proven IMAX movie experience that both film-makers and moviegoers identify with) and superior profitability (EBITDA margin in excess of 50%).

LM : I would watch Mattel ( MAT ), and if and when I see a major change in top management, I will assume that the company will have turned around in time to benefit from the 2018 fourth quarter so important for toys. This should then result in a sharp rebound in stock price to reflect the real value of the company rather than the extremely low share price level that exists today.

TID : My favorite idea for 2018 would be a company we have discussed in depth at ESCI. Roularta Media Group (ROU on Euronext Brussels) is a family-owned (65%) printing group which owned 50% of Medialaan NV, which includes Belgium's largest commercial TV and radio station. It didn't get any value at all on the market for its audiovisual exposure as the market was focusing on the poor performance of the printing business this year. In October, it sold that 50% stake to the joint venture partner for a total price (300M EUR in cash + 50% of a newspaper) which was higher than Roularta's own Enterprise Value at that point (255M EUR), indicating my assumptions and conclusions were absolutely correct.

It's still a 'work in progress' as the market still doesn't realize the full value of Roularta. Once the 50% stake in Medialaan will be sold, Roularta will have a net cash position of 14-15 EUR per share. This means that at the current share price of 21 EUR, the printing activities are valued at 75M EUR. Which is absurdly low for a division which generated 20.6M EUR in EBITDA last year. Even if we would apply a haircut of 50% on the existing print media EBITDA (to 10.3M EUR), Roularta's printing division will generate in excess of 25M EUR in EBITDA in 2019 as an operating lease (10M per year) will come to an end next summer whilst the 50% of the (financial) newspaper it received as part of the sale will also contribute 6M EUR in annual EBITDA.

This means the EV/EBITDA ratio at the current share price is still just 3 whereas a multiple of 8 seems to be warranted for a debt-free and cash flowing company. This would result in a sum of the parts valuation of 30-32 EUR per share. Roularta Media Group also is a perfect example of a family-owned smallcap which really shouldn't be public, and I think it's not unrealistic to see the family shareholders taking the company private in the next 6-24 months. Roularta was added to the ESCI portfolio at 15.97 EUR per share. I have now made an update article about the sum of the parts valuation which was published on September 6th available on my InstaBlog.

SV : I maintain a top ideas list as part of my monthly review for subscribers. One of the current ideas on that list is New York REIT ( NYRT ). The company is a real estate trust focused on New York City. It was the subject of an activist campaign, and shareholders agreed to liquidate the company. The New York City market has weakened, and the prices on the sales of the assets have been considerably below estimates, and way below the values originally floated during the activist campaign. That has left management with no credibility after they have repeatedly missed estimates, which has soured many special situation investors on the name. Additionally, the company will convert to a non-trading liquidating trust, which reduces investor interest further. These factors explain why the security could be undervalued, and some simple math confirms that it likely is undervalued.

The company's published NAV at the end of the last quarter was $7.93, and they have paid out $3.07 to shareholders since then, so the adjusted NAV is $4.86. At the current $3.90, that would imply a 25% return from here. Most of the remaining NAV after the distributions is from their holding in Worldwide Plaza. There is definite upside there, because they just sold slightly under half to SL Green and RXR who intend to reposition it and add value with already-allocated capital. Plus, they have deducted a $57 million accrual for transfer tax on the property, and all they have to do to avoid it is hold their current stake for 3 years, which is under their control and adds $0.34 per share in value. Finally, the IRR here will benefit from the fact that all the non-Worldwide Plaza assets should be sold with proceeds distributed within the next 6 months or so.

GSA : Colfax ( CFX ) is one stock which we believe can double over the next 3-5 years. The company was founded by Rales brother of Danaher ( DHR ) fame. Danaher's stock has given 20% plus CAGR since 1985. Colfax was also doing well till mid-2014 after which decline in oil and gas and power end market adversely impacted its fundamentals. The company's end markets have turned and its earnings are now improving. The company recently completed sales of its fluid handling business which has made it less cyclical and provided it with ~$1 billion firepower to make new acquisitions. Management is likely to announce a major "platform acquisition" over the next 12 months. The company is trading at 18.57x FY2018 cash EPS which is low given its improving outlook and inorganic growth catalyst. The company is likely to see accelerating earnings growth as well as multiple expansion over the next few years which can cause the stock to double. We have shared our detailed research on Colfax with our subscribers.


Thanks to our panel for joining us, we hope that turns up a few gems for you. If you're interested in any of our panelists work, check out the links below:

Follow the SA Marketplace account if you enjoy getting interviews and roundtable discussions with some of our top authors, as well as updates on what's going on with the Marketplace. We're wrapping up our year-end series over the next two days, and will be back to regular features next week.

Tomorrow's Theme: Biotech

See also SCHB: Reasons To Stay Long This Market on

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

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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