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5 great stocks the pros haven't found yet
Just because a company isn't on Wall Street's radar screen doesn't mean it's not a great opportunity. Heres what to look for.
By Michael Brush
With Wall Street dramatically cutting back on analyst stock coverage these days, literally thousands of tiny companies go virtually unnoticed.
Yet lots of these companies make the best stock plays around -- precisely because many investors havent figured out that the companies are, in fact, vibrant businesses growing at a healthy clip.
Then theres this potential kicker: Many smaller companies appear close to gaining substantial analyst coverage. When that happens, share prices tend to surge because the coverage puts those stocks on the radar screen at major mutual funds and draws money into the shares.
Theres no question coverage helps a lot, says Joe Dancy, president of Dallas-based LSGI Advisors, which specializes in microcap companies. He has spent years watching them shoot higher when they get their first analyst coverage. In fact, a small fund he manages for high-net-worth individuals was up 135% last year. A lot of these companies are inefficiently priced because their stories havent been told.
3 reasons companies win analyst interest
So, what companies are likely to get analyst coverage? To find out, we came up with a short list of qualities that help companies earn their first coverage. Then we found five fast-growing, undiscovered companies that fit the bill -- three with no coverage at all, and two with minimal coverage by a single boutique research shop.
To be sure, it can be tough to predict what stocks will get picked up by Wall Street analysts. Cynics suggest analysts favor companies that offer investment banking business. That may be true, but several other factors come into play, as well.
To come up with a short list, we turned to experts in this corner of the market such as LSGI Advisors Dancy. We also talked with small public relations firms that help micro-cap companies get coverage, including Investors Stock Daily of Rochester, N.Y., and PondelWilkinson of Los Angeles. We also checked in with Crownstone Group in Bensalem, Pa. This boutique research shop recommends uncovered biotech companies for clients.
Our experts say these factors get stocks analyst coverage:- Companies must operate in a niche where theres limited competition and potentially big growth. This is key for that first analyst coverage. Besides, if companies have this -- like the five we found -- they are more likely do well even if they dont get that coverage.
- The companies must be actively courting buy-side investors by going on road shows or presenting at conferences. Well call this the William Hung approach for the "American Idol" contestant who became a wild hit by appealing directly to the public. The companies get enough managers interested that trading volume picks up in their shares. This, in turn, gives analysts an incentive to start coverage, because their trading desks can make money trading the stock.
- They must have an ongoing dialogue with Wall Street analysts already, regularly fielding calls from them and meeting with them in person.
Here's a quick look at five stocks that fit the bill.
Barbeques Galore
The niche: Small retailer Barbeques Galore (BBQZ, news, msgs) generated $200 million in sales in its 2003-2004 fiscal year from 72 stores in the United States and 88 in Australia. It sells all the backyard grilling paraphernalia a barbecue lover could want, from grills and outdoor heaters to wood chips. But dont worry about Australia-based Barbeques Galore getting beaten out by low-cost, mass-market retailers. The companys niche is upscale barbecue lovers, which narrows the field. Plus, it took a page from the mass-merchant book and recently moved production to China to reduce costs.
The growth: Because Australians love outdoor cooking, Barbeques Galore is as well-known Down Under as McDonald's (MCD, news, msgs). Were an icon, says Sydney Selati, president of the companys U.S. business. Might some of that charm rub off in the United States, where the chain operates in California, the Southwest and the South?
Heres a possible answer: On March 30, Barbeques Galore shares jumped 71% when the company announced impressive 16% U.S. same-store sales growth for the fourth quarter of its 2003-2004 fiscal year. (The shares have dropped back a bit.) The results were a hint that something big may be stirring at this company. It plans to open six stores in the United States this year. We believe the U.S. has tremendous potential growth, Selati says.
The play for coverage: The company has a road show coming up in June. But excellent recent results have already caught the attention of Wall Street. "A lot of people have called me," says Selati. "A lot of investment bankers, buy-side analysts, sell-side analysts. A number of people have indicated they would like to initiate something on us, but I cant say if it will happen."
Aeterna Laboratories, AELA
The niche: Aeterna Laboratories (AELA, news, msgs), a tiny pharmaceutical company headquartered in Quebec City, Quebec, has two compounds that are well on the way for approval for treatment of cancer and uterine problems, says Fredric Cohen, president of Crownstone Group, the research firm that specializes in biotechnology. (A physician, Cohen is also a former research strategist at Johnson & Johnson (JNJ, news, msgs).)
The potential cancer drug, called Perifosine, works by inhibiting AKT enzymes, which thwart chemotherapy by protecting cancer cells. The other compound, Cetrorelix, already used in in vitro fertilizations, may one day treat uterine tumors and cysts, as well as enlargement of the prostate gland.
Aeternas stock has more than doubled so far this year. Aeterna has $42 million in cash and a low cash-burn rate. It already gets revenue from the sale of several drugs. And it has a 62% stake in a profitable nutritional supplements business called Atrium.
The growth: The National Cancer Institute is testing Perifosine for use against six different kinds of cancer. "It could be used in combination with a lot of drugs to treat a wide variety of cancers," says Cohen. The market for Cetrorelix could be large, as well.
The play for coverage: The way Cohen sees it, biotech companies typically must have at least one drug in Phase III testing to get coverage by analysts in the United States. If all goes well, both Perifosine and Cetrorelix should move into Phase III testing soon.
Three other factors may help draw coverage as well, Cohen says.
- The company might spin off its holding in Atrium, which means it would need investment banking advice.
- Management has experience bringing drugs to market.
- The company already has analyst coverage in Canada.
In the last month, our chief financial officer has been in New York on an ongoing basis," says Gilles Gagnon, Aeternas president and chief executive. "My feeling is that there is a huge interest in our company."
Natural Gas Services Group
The niche: Rising natural gas prices have caused energy companies to re-examine reserves they once left for dead, says LSGIs Dancy. At the same time, they want to get gas out of the ground as fast as possible in newer fields. The natural gas compressors made and leased by Natural Gas Services Group (NGS, news, msgs) help producers do just that. The gear increases the pressure in underground reserves, speeding up production. Based in Midland, Texas, Natural Gas Services is the only public company offering smaller wellhead compressors operating at 600 horsepower or less, says CEO Wallace Sparkman.
The growth: Natural Gas Services has annual earnings growth well into the double digits; Dancy thinks the trend should continue because of tight domestic natural gas supplies.
The play for coverage: The company makes its case to money managers on a regular basis. And Wall Street firms are circling. There is one large firm that has the door open right now for some banking business, says Sparkman. If financing comes through, he thinks research should follow. The stock is 37.3% higher so far this year, and trading volume has picked up, which should make trading desks happy.
Telkonet, TKO
The niche: If Telkonet (TKO, news, msgs) is right about a patent it holds, it may be the only company around that can sell equipment to transmit broadband signals over the electrical wiring in buildings. Why run broadband over electrical wires? For hotels and large apartment buildings, it can be a lot cheaper than installing new wiring. Based in Annapolis, Md., Telkonet also has potential customers in government and defense, where broadband over power lines (BPL) might be used on Navy vessels. In Europe, BPL may someday help large companies sidestep pricey phone service by running voice over Internet protocol (VoIP) on electrical wires.
The growth: Telkonets business is so new, it hasnt even worked out all the details on pricing. Indeed, it describes itself as a development stage company. And, while the company has racked up about $12.2 million in losses since it was launched in 1999, it has inked deals with 100 hotels and a handful of apartment buildings. Several military bases and ships are testing the system. The potential market is huge: There are 40,000 hotels and 30 million apartment buildings in this country alone, says Ron Pickett, Telkonets president and chief executive.
The play for coverage: Telkonet already has one small shop covering its stock but no major firms. The company is making the rounds of tech conferences and fund managers. Weve got sophisticated money that has turned us upside down and shaken us and said this holds a lot of water right now, says Pickett. The company has also attracted Wall Street interest, says Jody Janson whose Investors Stock Daily accepts money from Telkonet to promote the stock. The company probably needs a few more quarters of revenue growth before more analysts bite. The stock is up nearly 70% this year.
Omni Energy Services
The niche: Thanks to high crude oil and natural gas prices, 3-D seismic mapping of hydrocarbon deposits is in huge demand. The technique makes it a lot easier to locate and drill energy reserves. Omni Energy Services (OMNI, news, msgs) plays a key role by securing permits and preparing sites for the blasts used to help create the images. More important, the Carencro, La., company specializes in the marshy areas along the Gulf Coast in Texas and Louisiana. Natural gas deposits are plentiful in the region but tricky to tap into because of quirky underground geology, says Dancy of LSGI Advisors, who has a position in the company. Omni also provides helicopter transport to offshore rigs.
The growth: As long as natural gas prices stay high, demand for seismic mapping will stay robust. Our business is extremely good, and it is only getting better, says G. Darcy Klug, Omni's CFO. We dont see that changing in the foreseeable future. The company is also growing by buying out competitors.
The play for coverage: Omni is covered by only Spelman Research in New York. The company is a turnaround. New management came in during April 2001 and spent the last two years building a business to where we would have a story to tell Wall Street, says Klug. This year, it has been reintroducing Omni to money managers, and the company is going on a road show this quarter. We think at that point in time we will pick up coverage again, says Klug. The shares were up 33% by mid-March but have given the gains back.
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