Newsletter Watch: Favorite growth and value small caps

Steven Halpern | Apr 18, 2008 6:20am EDT | 1 Comment

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Richard Moroney, editor of Upside Stocks, applies quantitative analysis to the search for growth and value-oriented small-cap stocks, most recently choosing small caps EZCORP, Inc. (Nasdaq:EZPW) and Natural Gas Services Group, Inc. (AMEX:NGS) as “buys” through his proprietary Quadrix system.

According to the advisor, who is also well-known for the blue chip, large-cap-oriented Dow Theory Forecasts, now might be a particularly good time for investors to consider small-cap stocks. After completing a rigorous analysis of stock performance and valuations, he says, "As the price/earnings ratios of small stocks have contracted, those of the fastest growers have contracted the most."

He says that since last Sept. 30 (when the S&P SmallCap 600 was within 5% of its all-time high), the median P/E ratio for all stocks in the index has dropped to 16.8 from 19.4, a 13% decline.

"Among the one-fifth of S&P 600 stocks with the highest expected five-year profit growth, the median P/E has dropped to 22.7 from 29.9 — a 24% decline." His conclusion? "Investors' reluctance to pay up for growth stocks represents an opportunity, provided you're selective."

It is this "selectivity" that is the key to success, according to Moroney. "You should not limit your search to companies with just the very best expected growth rates, partly because such consensus forecasts are not very accurate."

Rather, the advisor says the current environment argues in favor of a focus on both growth and value. "With the overall outlook for corporate prospects deteriorating, you should consider redoubling your search for attractively valued growers," he says.

How, then, does Moroney isolate those stocks that meet his criteria for both long-term growth and sound fundamental value? The advisor has developed a proprietary system known as Quadrix, where all stocks are run through a detailed screen, and earn a score based on a variety of metrics.

The scores within this system are percentile ranks, with 100 being the maximum rating a stock could receive. According to Moroney's strategy, a stock's overall Quadrix score depends on how it scores on ranking with the following areas:

• Momentum (recent operating results).
• Value (P/E, price/cash flow, and other valuation ratios).
• Quality (long-term growth record and returns on assets, equity and investment).
• Financial Strength (debt levels, interest coverage and profit margins)
• Earnings Estimates (trends in analyst estimates).
• Performance (stock returns).

Using this strategy, EZCORP and Natural Gas Services recently earned a “buy” rating via Moroney's Quadrix system. EZCORP offers pawn loans and sells forfeited merchandise through 319 EZPAWN locations.

The company, he says, also provides short-term personal loans, or payday loans, through nearly 450 EZMONEY locations.

"In fiscal 2007 ended September, 41% of net revenue came from short-term lending. The average pawn loan ranged from $80 to $100, while payday loans averaged $540. December-quarter earnings per share rose 26% to $0.29, topping the consensus by a penny. Overall revenue rose 22%, fueled by a 37% increase in loan revenue."

Steady store growth and an expanding presence in Mexico, he says, should bolster results. For the year ending September, he says, management targets per-share earnings of $1.13, implying 28% growth. In fiscal 2008, management expects to open roughly 100 EZMONEY locations in the United States and add seven to 10 pawn locations in Mexico, he says.

Regarding its valuation, "EZCORP, modestly valued at 11 times expected fiscal 2008 earnings, is being initiated as a ‘buy,’” Moroney says.

Also added to his “buy” list is Natural Gas Services, a leading provider of compressors to the energy sector. The stock, he says, is capable of rallying 15% to 20% over the next 12 months.

"The company has carved out a lucrative niche, and solid industry fundamentals should drive robust growth,” he says. “Natural Gas Services focuses on non-conventional and faster-growing gas markets in the United States, including coal-bed methane and gas shale."

December-quarter earnings per share surged 58% to $0.30. Revenue rose 18%. For full-year 2007, per-share profits jumped 53% on a 16% revenue gain. Results, he cautions, are subject to changes in capital spending by petroleum companies.

Still, he says, an expanding footprint and growing compressor fleet bode well for earnings. Consensus estimates project per-share profit growth of 16% in 2008 and 26% in 2009, Moroney says.

For 25 years, Steven Halpern has conducted an annual survey asking the leading newsletter advisors to select their favorite stocks for the year. His 2008 report features 120 top picks. You may download the report for free by clicking here.

About the Author
As a newsletter editor and financial journalist, Steven Halpern has covered the investment newsletter industry for 25 years. Read More