2014 is here and if you are looking to adjust or find some stocks to make an impact to your portfolio, then why not consider some small caps?
2013 was a great year for both small and large caps, but as the market continues to go up and gives the impression of improvement, expect more people to start plowing their money into the stock market.
That’s where choosing wisely and looking where others are ignoring will be an advantage.
After all, the winning investors are those who flip over the most rocks in search of value.
Over the past several months, I’ve been making my way through America’s Best Small Companies and each of the three stocks you see here have the following characteristics.
- strong sales and earnings growth
- publicly traded for at least a year
- generates annual revenue between $5 million and $1 billion
- stock price no lower than $5 a share
Let’s get started.
1. Synaptics (SYNA)
You’ve encountered Synaptics, Incorporated (NASDAQ:SYNA) so many times in your everyday life already. They are the ones that makes touchpads on laptops and touchscreens on phones, tablets and touch screen computers.
Synaptics, Incorporated (NASDAQ:SYNA) is a company with technology and products entrenched in our daily lives. It isn’t a flashy non-profitable software or social media tech company.
The company has some great stats as a value play which I get to below. To add to that, the valuation isn’t over the top which makes things even more interesting.
First a quick brief.
- Market Cap of $1.7B
- Sales Growth: 11%
- EPS Growth:26%
- TTM ROE of 24%
- Cash Adjusted PE: 13.6
- EV/EBITDA: 9.5
The main highlight that jumps out at me is that Synaptics, Incorporated (NASDAQ:SYNA) is a profitable tech company, growing revenues, increasing margins and virtually no debt.
Yet it is priced priced attractively.
Revenues has increased by 14.4% in the TTM and at the same time, Cost of Goods Sold has decreased leading to an increase in gross margins to an all time high of 49.3%.
This has trickled down to net margins where it is sitting at 16.8% in the TTM.
Mobile phone adoption continues to increase and phone manufacturers will churn out more phones in 2014.
Synaptics, Incorporated (NASDAQ:SYNA) is set to benefit and this industry growth is what has forced the company to spend more on R&D which is now also at peak levels in the 20% range.
Fundamentals and Valuation
Synaptics has some awesome numbers.
The balance sheet is healthy with only $2.3m of long-term debt which is nothing compared to the cash on hand of $331m and free cash flow generating ability.
The cash conversion cycle increased in 2013 to 45 days compared to 40 days in 2012. While a 5 day difference may not seem like much, when you break it down and compare the differences, days in inventory went from 54 days compared to 40 days the prior year.
In other words, inventory is sitting in the warehouse for a longer period before it is sold. Although business is good at the moment, inventory is always something to watch for.
When it comes to valuation, the multiples are enticing.
Since Synaptics, Incorporated (NASDAQ:SYNA) is currently in it’s Q2 of fiscal 2014, a better proxy is to look at the 2013 multiples.
SYNA Valuation Multiples
If you take the stock price out of the picture, by looking at the above numbers, you would think that it is priced similar to 2011 when it was in the $25-$30 range.
But the stock price is at $50 and sounds a lot more expensive when you begin to anchor on price.
But the numbers show that the fundamentals have been driving the stock price instead of speculation and hope like a lot of stocks.
Also, take a look at free cash flow.
Capital expenditure increased 3x and accounts receivables increased by 42% compared to 2012.
But when you take a look at Buffett’s owner earnings which ignores the effects of working capital, it is on a tear.
With these two sets of numbers, I can quickly come up with a price estimate based on two different cases by checking what the market expectation is via the reverse DCF method.
Then after adjusting the FCF/owner earnings based on a bearish, normal and optimistic case, I get the following numbers from my stock analyzer.
- Base case estimate: $45
- Normal case estimate: $62
- Optimistic estimate: $75
With a margin of safety, I’ll be more than happy to pick up shares of Synaptics if it drops below $40.
2. Syntel (SYNT)
Syntel, Inc. (NASDAQ:SYNT) is an outsourcing company and gets 75% of its revenues by building applications for other companies.
Application outsourcing includes everything in the product cycle. Development, maintenance, testing, building the infrastructure and hosting too.
Its other businesses include
- Knowledge Process Outsourcing (KPO) which is a lot like Business Process Outsourcing, where back office tasks and administration is outsourced.
- e-business is focused on advanced technologies and data analytics to solve business problems
- and teamsourcing is more of a consulting gig for companies looking for advice and help
Not all companies have the luxury of being able to afford and maintain such specialized teams and so it’s better off to outsource these tasks.
Previously, I highlighted ExlServices. Like most companies in this space, Syntel, Inc. (NASDAQ:SYNT) uses the strong Indian IT industry to deliver quality products at a cheap price.
- Market Cap of $3.8B
- Sales Growth: 17%
- EPS Growth: 20%
- TTM ROE of 32%
- Cash Adjusted PE: 16
- EV/EBITDA: 13
When I think of outsourcing companies, the first thing I think of is the switching cost. It’s a thorn to switch to another company. That’s why the outsourcing industry is very fragmented but all players survive and do well.
Once a company gets big, it starts facing issues with being slow, inefficient, and wanting to cut cost. So that’s where an outsourcing company will win a few contracts here and then. It then leverages that experience to other businesses, building credibility and a steady customer base from there.
The biggest company in the industry that I can think of is Cognizant Technology Solutions Corp (NASDAQ:CTSH) which has a market cap of $30b. 10 times the size of Syntel, Inc. (NASDAQ:SYNT) .
I bring this up because size doesn’t matter in this space and from the numbers below, you can see why as Syntel is very profitable.
Fundamentals and Valuation
The balance sheet is healthy with a current ratio of 6.71. The company took on $140m of debt in the latest quarter, but seeing how the interest rate they are paying is only 1.51%, getting money that cheap is a good move.
Paying 1.51% in interest is close to free.
How they spend it is another matter, but there is more than enough FCF to pay the loan payments and as long as the return is greater than 1.51%, it is a smart decision.
The only point I want to nitpick is the low Piotroski score.
A score of 4 is low compared to the type of return this business is generating.