Re-Ranking the Forbes 'Best Small Caps' List
NEW YORK (
) -- Study after study has confirmed that small caps outperform large caps as a group over the long run. Some good small-cap ideas we'll look at below include
Pre-Paid Legal Services
( PPD),
Sturm, Ruger
(RGR) - Get Report
,
Deckers Outdoor
(DECK) - Get Report
,
Darling International
(DAR) - Get Report
and
Quidel
(QDEL) - Get Report
.
There are
many arguments
to support owning small caps in your portfolio. Yet, investment banks, money managers, TV pundits, and research firms generally ignore them.
The inclusion of small-cap stocks is one of the main reasons Joel Greenblatt's Magic Formula Investing keeps outperforming the market. The hedge-fund investor's strategy works fine for stocks with more than $1 billion market caps, returning 20% annually between 1988-2004 (as shown in
The Little Book that Beats the Market
). But when you expand the universe of stocks to include those with a market cap of $50 million or more, the performance vastly improves, returning nearly 31% annually over the same period!
Perhaps the most intriguing list of small-cap companies is produced every fall by
Forbes
, in its
. This year,
Forbes
editors picked 100 publicly traded companies with sales under $1 billion and a stock price above $5, filtering out firms with accounting and/or legal troubles. Then it ranked those stocks based on an unspecified recipe including earnings growth, sales growth and returns on equity. The result is a universe of what I found to be very intriguing small-cap companies.
I thought it would be interesting to apply the Magic Formula ranking
system of earnings yield
and
return on adjusted capital
to see which of these firms best met the "great companies at cheap prices" goal of MFI. Below are the rankings.
One
Forbes
stock,
Portfolio Recovery Associates
(PRAA) - Get Report
, has an asset-based business model (like a bank or insurance company) and was excluded. Entries with an asterisk currently appear in the
official MFI screens
. The statistics below were calculated using
the MFI stats calculator
tool.
So, where can we go to find good small-cap ideas? MFI is certainly one place. Here is our analysis on
Pre-Paid Legal Services
,
Sturm, Ruger
,
Deckers Outdoor
,
Darling International
and
Quidel
.
Steve Alexander is the founder and editor of MagicDiligence.com, a site that analyzes stocks appearing in hedge-fund investor Joel Greenblatt's Magic Formula Investing screens. Alexander is a private investor with more than a decade experience in the market.
