If you want to find a real home-run investment, you are not going to find it in large-cap stocks. They’ve already had their glory days. They’ll provide you with stability and reliability, and even a dividend. But the key to outperforming the market and your peers rests in your ability to hunt down undervalued small-cap stocks. I have three stocks that have been totally overlooked by the market that I believe are set to triple from current prices. The stories are beyond compelling. EZCorp
EZCorp (NASDAQ:EZPW) is exactly the kind of Peter Lynch stock that deals in an area that some might (wrongly) find distasteful, but is enormously profitable and totally overlooked. The company owns more than 1,000 pawn and payday loan stores in the U.S., Mexico and Canada. Mexico, in particular, is a solid new growth engine for EZCorp. As EZPW and its competitors jockey for position down south, they stand to reap big benefits, as 80% of Mexico’s population are potential pawn customers vs. 20% in the U.S.
EZCorp has been seeing sizable same-store-sales growth in pawn. Analysts are projecting 30% earnings growth this year, 20% next year and 15% beyond. I believe that 15% number is low. A 25 P/E on next year’s earnings of $3 gives EZPW a fair value of $75, a triple from today’s prices. The company has $27 million in cash and about the same in debt, and is seeing huge increases in free cash flow every year.
Akorn, Inc.
Akorn, Inc. (NASDAQ:AKRX) engages in the manufacture and marketing of diagnostic and therapeutic pharmaceutical products, hospital drugs and injectable pharmaceuticals. Akorn is a highly specialized company and has 22 drug applications sitting with the FDA, looking to capture a $3 billion market. Analysts see 25% annualized growth over the next five years, or 66 cents per share in 2015, but my own research suggests that’s an undervaluation.
I see revenue from a randomized sample of possible approved drug applications vastly exceeding analysts, and see about $1 per share in 2015, meaning AKRX stock would have a fair value of $25. In the meantime, the company sits on $134 million in cash and $99 million in debt. Unlike many pharmaceutical companies, Akorn isn’t burning cash. In fact, it has positive free cash flow of almost $10 million this year.
8×8 Inc.
The oddly named 8×8 Inc. (NASDAQ:EGHT) develops and markets telecommunications services for Internet protocol (IP), telephony and video applications. The company offers 8×8 Virtual Office Business Telephone Service, an alternative to traditional private branch exchange systems that offers automated attendants to assist callers. This story is all about the company’s products, and they are being adapted by a lot of businesses.
8×8 reported earnings Wednesday and saw sequential revenue growth of 7%, and year-over-year increases of 14%. Churn is only 2.2%, meaning customers stick with the company’s products. Despite this, the market saw fit to discount the stock even further, creating an even greater bargain. The company’s earnings look set to double by FY13, and 27% annually thereafter. The beautiful thing about this microcap company is that is has no debt, and $19 million in cash, giving it an effective stock price of only $3.57. For those interested in return on equity, EGHT is tearing it up: 44.5%. That’s almost impossible to find. I believe 8×8 will be earning 50 cents per share in FY16, and a 27 P/E gives a target of $13.50.
Of course, one can never be certain how microcap and small-cap companies will fare in the future. That’s the point of risk/reward, however. If you are fine with mid-single-digit returns, that’s why there are stalwarts. But if you want to roll the dice and go for the gold, that’s why there are stocks like these.
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