At a time when good information about the stock market is needed more than ever, investors are finding that just the opposite is happening. The downturn in the market and the economy in general, the disappearance of brokerage and investment banking firms (such as Lehman Brothers and Bear Stearns, plus smaller ones), the financial difficulties Wall Street now finds itself in -- all contribute to a shrinking pool of available information about stocks.
This is demonstrated by looking at the number of analysts following stocks. When firms had to separate their research from their investment banking starting at the beginning of this decade, my impression was the number of analysts started to decline. But the last year has really taken a toll. This was made clear in a recent article in The Wall Street Journal, which reported that between September 2008 and May 2009, "there were more than 2,200 cases of analysts formally dropping coverage of a company, representing about a quarter of research reports during that period." As an example, the Journal talked about how, in the last year, a small technology company went from having seven analysts following it, to one analyst.
Why should you care? Large companies have and generally will continue to have plenty of analysts who follow them. But small and even mid-cap companies are finding it difficult to get coverage, which means many good companies get little or no publicity on Wall Street.
I mention this because the system I use to identify stocks is not based on the writings of analysts and, most importantly, looks at about 6,000 stocks on the New York Stock Exchange and Nasdaq which account for about 99% of the volume of shares trading on these exchanges. Because my computerized system automatically sorts through so many listed stocks on these exchanges, I am able to find some gems where others rarely look.
The Journal notes that a company like Scholastic (SCHL), a publisher of children's books (including the Harry Potter series in the US), and which has a market cap of over $700 million, has lost several analysts in the past year and is now down to three. While Scholastic does not currently meet the minimum requirements of any of the Guru Strategies I follow, so I do not recommend it, it is an example of a solid, fairly well-known company that is shedding analyst coverage and finding it tough to get its story told to investors. Three analysts are not many.
Imagine all the companies that are less well known than Scholastic -- many of these are likely to have few if any analysts covering them. In such cases, it becomes difficult for average investors to learn about companies that might have excellent prospects.
With this in mind, I decided in this column to look for some smaller, lesser- known companies to tell you about. These are the types of companies that generate minimum media or analyst coverage, yet have excellent prospects, as measured by the Guru Strategies.
One of these companies is AZZ (AZZ), which markets products used in the generation and distribution of electricity, as well as galvanizing services, which are used to help prevent the corrosion in steel products. The company's market cap is about $400 million.
The Guru Strategy I based on James P. O'Shaughnessy's writings is very favorably impressed by AZZ. It likes its market cap, the fact that earnings per share have increased in each of the last five years, and its price-to-sales ratio, which is a desirable 0.90 (1.5 or less is required). Further, the stock's relative strength (a measure of how well AZZ's stock did in the past 12 months versus the stocks on the S&P 500) is 91 -- it outperformed 91% of the stocks on the S&P 500. AZZ -- its stock and the company -- are strong performers, and should continue to be so. This is a good time to buy AZZ.
Pre-Paid Legal Services (PPD) provides legal service benefits through a network of independent law firms across the US and Canada. The services include unlimited attorney consultation, will preparation, traffic violation defense, automobile-related criminal charges defense, letter writing, among other services. The services are reimbursed much like the workings of medical reimbursement plans. The Guru Strategy which emulates Warren Buffett's strategy gives Pre-Paid Legal Services high marks because earnings per share have increased in each of the past 10 years, earnings can pay off debt in less than a year, and average annual return on equity is a strong 42%. Also impressive: the company has been earning 60% average return on capital. Cash flow per share is positive and the investor can expect an average annual rate of return on the company's stock of 23%. You don't need an iron-clad legal contract to know that Pre-Paid Legal Service is an excellent investment opportunity.
The last small profile company I want to mention is RTI International Metals (RTI), which manufactures specialty metals for the aerospace, industrial, chemical, and consumer markets, as well as being one of the world's largest producers of titanium. According to my Peter Lynch-based Guru Strategy, RTI is a fast grower, because its growth rate of 39% is above the 20% threshold required to be labeled as such. The Lynch strategy's most famous variable is the P/E/G ratio, which compares the price-to-earnings ratio to the growth rate. A P/E/G of 1.0 or less is required, and less than 0.5 is considered very favorable. RTI's P/E/G is a titanium-proof 0.25, which means investors pay relatively little for growth. A couple of other factors in its favor: inventory as a percentage of sales is falling (which indicates management is doing a good job managing inventory) and debt equals about 40% of equity, which is a modest amount of debt.
AZZ, Pre-Paid Legal Services and RTI fly under the radar screen of many investors. Wall Street's cutbacks on its research presents opportunities for investors. I think these three companies are likely to do well, even if Wall Street generally ignores them. And it is not just me who thinks so, but so do the Guru Strategies.
Published by Globes [online], Israel business news - www.globes.co.il - on June 3, 2009