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Another Catalyst for the Micro Cap Newsletter

March 28, 2012 | About:
Paul Andrews

Paul Andrews

7 followers

It’s been quite an interesting month for the Micro-Cap Magic Formula newsletter. Last month, one of our picks was bought out for a huge premium to our purchase price. And now Crown Crafts (CRWS), the first stock we added to the portfolio (from all the way back in May — has it been so long?), announces a huge increase in their dividend and sees their stock rise 23% in one day!

It’s been quite a volatile ride with Crown Crafts, but overall it’s been a pretty profitable one — the stock is up over 10% from our purchase price after factoring in dividends. And you could easily be up more than that — the stock traded well below our purchase price for most of the past six months.

But we’re not writing this article to brag.

Well, maybe we’re writing to brag a little bit.

But we’re mainly writing to discuss what the newsletter got right in picking Crown Crafts and show how it reflects on what we try to do each and every month in the newsletter.

First, Crown Crafts was cheap. There was no doubt about that.

We noted in our article that Crown Crafts was trading for barely more than 5x EBIT and an equally low multiple to historical EBIT. Not only is this cheap in the absolute, but CRWS traded for about half the multiples of all their peers on just about every metric.

So there was plenty of upside.

And Crown Crafts was not only cheap, but it also had historically strong ROIC and a defensible niche from which to keep earning strong ROIC. Plus, it had little capital reinvestment requirements, so cash flow was actually higher than reported profits.

Those are characteristics of all the stocks we pick for the Micro-Cap Magic Formula newsletter: high ROIC, strong earnings history, good cash flow.

But just it’s the next two that really sets us apart.

First, Crown Crafts is small. It’s located in a small city in Louisiana, and its market cap was less than $50 million. We were fishing in some fertile waters here: Few investors are going to spend any time investigating a tiny company from the South. Most professionals manage portfolios bigger than CRWS, so they can’t waste time on the company, and individual investors aren’t exactly chomping at the bit to invest in Louisiana micro-caps. Plus, Crown Crafts engages in a boring business. No one gets excited about investing in baby blankets!

In other words, the odds a steady cash flow generator like CWS would be neglected by the market were pretty high.

But perhaps most importantly, we only have a one-year time frame for holding picks in the newsletter.

I invest my own money into each pick, and the worst thing I could imagine is picking a stock, having it do nothing for a year, and then seeing it rise to fair value six months after selling.

So each stock has a strong catalyst for value realization to minimize those chances. Here’s what we said about CRWS when we wrote about it back in May:

“In addition to returning almost $5 million in dividends and share repurchases and $6.8m in acquisitions over the past four years, the company has paid down almost $19 million of debt and should be net debt free within the next six to twelve months. Once the company is net debt free, they could initiate a much larger share repurchase plan, lever up the balance sheet.“

Lo and behold, here we are 10 months later, and the company’s paid down the last of their debt and is raising the dividend! It’s almost like we saw this coming!!!

To wrap it up, each month we try to hit the value trifecta: cheap business, strong niche and good catalyst. It’s a very fun portfolio to follow, and the results so far speak for themselves.

So why not check us out? The newsletter comes out the second Friday of every month, and while we can’t promise every stock is going to turn out like CRWS or APNC, we can promise that we will introduce you to a tiny company with an interesting niche trading for a low multiple each and every month.

 


Rating: 3.9/5 (12 votes)

Comments

Adib Motiwala
Adib Motiwala - 2 years ago
Good stuff. Question. What did you mean by once they are net debt free, they could initiate a much larger share repurchase plan, lever up the balance sheet."...
Bob_in_Maryland
Bob_in_Maryland premium member - 2 years ago
Thanks for the perspective. The fundamental analysis found in the Micro Cap Newsletter is absolutely super. As one holds a position, even greater insights emerge. Price action with Crown Crafts was off-setting last year. As a result, I sold short. Know that goes "against the grain" of our understandings but taking a short position - at a certain point of loss just fits my disposition. Because I monitor previous holdings in late January: got back in but with a smaller position. Having a healthy portion of small/micro cap corps in a portfolio makes sense. Going long becomes easier, then. Guess I'm saying that monitoring these small caps requires a lot of effort. Case in point, in spite of the dividend increase, CRWS's shareholders should remain attentive to the exchanges that took place with Patricia Stensrud (who was nominated to the BoD by Wynnefield Partners). She brought up concerns over management succession and making changes to the firms' corporate guidance. My understanding is that this ended with an agreement. However, as time moves on, it is matters like these that really determine whether a position should be added to. Or not. It would really be interesting to see how the letter's followers apply their strategies once they accept the guidance/advice.

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