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Valuation Analysis Of The Best Small Companies of 2014

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Prepare to Make Money in 2015 with the Best Small Companies of 2014 by Jae Jun, Old School Value

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Jae Jun

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Each year, Forbes releases their list of the best small companies in October.

Why October?

I don’t know

But it does push me in the right direction of looking at new companies or to revisit old ones as it gets to the end of the year when it’s much too easy to relax and unwind.

I started going through this annual list starting in 2008 and I’ve had good success with it.

I don’t buy everything on the list because many stocks are clearly overvalued. However, the list is always full of new names which is always good to build up your knowledge and idea bank.

The methodology used by Forbes in finalizing these small companies is quite simple.

  • strong sales and earnings growth
  • strong ROE in the TTM and over 5 years
  • publicly traded for at least a year
  • generate annual revenue between $5 million and $1 billion
  • stock price no lower than $5 a share
  • excluded financial institutions, REITs, utilities and limited partnerships

In addition to these, here is how the rankings are calculated.

The rankings are based on earnings growth, sales growth and return on equity in the past 12 months and over five years; we dropped thinly traded names and those with fuzzy accounting or major legal troubles. We also factored in stock performance versus each company’s peer group during the last year as of Oct. 1. The five-year results for sales growth, earnings growth, ROE and stock performance were weighted twice as heavily as the one year figures.

Now, there is no single system that will outperform the market every year.

Any mechanical strategy is bound to underperform once a while and 2014 was the year for the Forbes list.

The average performance last year was -2% which underperformed the Russell 2000 small cap index benchmark.

But like I said, some companies were grossly overpriced and if you avoided those names and picked your spots, you would have come out on top for sure.

Small Companies

My Methodology to Go Through The 100 Stocks

My process is simple.

Since these 100 stocks have already been vetted by the Forbes staff, I trust that the accounting for each company is fine.

Here are the basic steps I take in going through the list.

Step 1. Perform Quick Valuations with Necessary Adjustments (~ 5 Minutes)

The idea is to first quickly get rid of companies that are overvalued with a quantitative approach.

My go to tool is obviously the Old School Value Analyzer.

Here’s what I do.

  • Perform quick valuations (e.g. DCF, Graham, EBIT)
  • Check valuation ratios (e.g. EV/EBITDA, P/FCF, Earnings Yield)
  • Check quality scores (e.g. Piotroski, Altman Z, Beneish)

An important point is that I’m not just using default values.

I take a look at important numbers like FCF, historical growth and the default growth that the analyzer is using, to compare and check whether the assumptions for the valuations are realistic.

Then I make adjustments here and there to get my final output.

This part usually takes me about 5 minutes at most.

Out of the 5 stocks that I randomly selected to use as an example, Sun Hydraulics Corporation (NASDAQ:SNHY) came up on the list.

It’s currently ranked 44 on the list and because I haven’t studied it in detail, I won’t say it’s overvalued.

But it certainly doesn’t look like a buy initially.

Small Companies
Valuation Ratios for SNHY

Graphically, here’s an example of what I get.

Small Companies
Price to Intrinsic Value Based on DCF

But wWith 99 other stocks to go, I’m fine with skipping SNHY as I know something better will show up.

Step 2. Financial Statement Analysis Checks (~ 10 Minutes)

If the step 1 valuation checks out, then it’s onto financial statement analysis.

  • Checking the balance sheet and the balance sheet ratios
  • Looking at the flow and consistency of the margins
  • Perform some advanced analysis like inventory analysis, DuPont analysis and accruals check

Since I’ve also automated the process and use the OSV tool to help me out, I can do this in less than 10 minutes.

It only takes me 10 minutes because I’ve looked at so many companies and run through their numbers. I have my own method of what to look for which I’m always trying to fine tune, but I can’t improve or know what to look for without actually going through long lists one by one and be willing to look at companies.

This varies for everyone and there is no single way of doing it. Even if you don’t have any tools to help you, it’s just a matter of getting started.

Manually write or type those numbers and crunch them. Getting started and then getting into a habit of going through them is what is going to reduce your analysis time.

It’s not easy.

But the more you do, the better you get.

The good thing with the Forbes list is that I haven’t come across a company where the financials were horrible. They are straight forward and help you get more comfortable with financial statements.

Step 3. Reading to Understand the Company and Industry (No Time Limit)

This is always the longest process and there is no time limit.

There are specific industries that I am;

  1. comfortable with
  2. understand well
  3. or is easy for me to learn and understand about

Software, online services, tech, machinery and audio are some of the industries that I’ve always had an interest and passion in so it’s easy to pick up.

However, there are more industries I don’t know about.

And to learn about them, it requires reading.

The minimum amount of reading required are the filings.

*The bare minimum*

The filings are there for regulatory purposes and if you climb into the head of management, they would love to just leave out as much info as possible.

Despite how “shareholder friendly” management claims or seems to be, most managers hold shareholder interest well below below their own self interests.

And if that means being allowed to leave out information legally, it will be done.

Don’t expect management to be your best friend and tell you everything how it is.

That’s why additional reading is always required.

Whether it be through in depth industry articles, white papers, old news articles about the management team etc, the filings are the start.

Step 4: Buy a Small Position to Start

One way I motivate myself to continue reading is by buying a small starting position.

Go back several years and I normally purchased a company in one big gulp.

Did all my number crunching, reading, analysis, comparisons and then bought a full size position in one go.

Not anymore.

Even a $1 position changes your perspective and with money on the line, it’s always a good motivator to keep going.

Plus I find that knowledge and insight increases the longer I hold my position.

I look back at a lot of my holdings when starting out and the initial reasons for buying actually turned out to be surface layer analysis.

Despite the hours of reading and looking up info before buying the company, the reading and research I was doing after buying the stock was in fact better and higher in quality.

It’s only after holding for a while where I can see much clearer where the company is heading, how the industry is evolving and how it will impact the company.

And by buying a small position to start with, if any mistakes were made initially, it’s easier to sell, learn and move on.

The Benefit of Doing This

Knowledge and research is accumulative.

For the past 6 years of following this list, I’ve built my own database of companies that I’ve reviewed.

It just makes finding and looking out for ideas so much easier.

Out of the 100 stocks in the current list, there are already a handful that I’ve researched previously that I’m waiting to buy.

I thought the dip in October was going to help me out, but looks like I have to wait longer.

It’s a proactive way to maintain a buy list and pushes me to focus on companies instead of listening to incorrect or bad advice from the media.

Download the Free Spreadsheet with Detailed Stats of All 100 Companies

I’ve done all the work for you by finding the tickers of each company and updating the stats for each company.

Now it’s up to you to decide whether you want to go through these companies or not.

100 is a lot.

But it’s worth it.

Just click on any of the buttons to share this post and the download link will appear.

This post was first published at old school value.

You can read the original blog post here Prepare to Make Money in 2015 with the Best Small Companies of 2014.

Lastly, Check Out These Related Posts
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  3. 200 Companies from 2009 Revisited and Revalued
  4. Best Small Companies Update and 4 Stocks to Watch
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