3 Small-Cap Stocks With Big Upside

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October 28, 2015 12:55pm ETF BASIC NEWS

money and investingLawrence Meyers:  I love the small-cap value sector, more than any other sector in the equity market. Small caps in general outperform large caps over time, because the returns when small companies become large companies are going to exceed those of large companies that become even larger.


Yet value stocks are more likely to give you multiples on your investment than growth stocks, since they tend to be overlooked gems that can attract big investment interest when they break out.

Here are three small-cap stocks I believe are significantly undervalued.

A Hotel REIT

Ashford Hospitality Prime (NYSE: AHP) is a hotel REIT that was spun off from Ashford Hospitality Trust (NYSE:AHT). Prime holds the company’s more upscale hotels in its portfolio. These properties have historically generated excellent revenue and profit, yet the market is drastically undervaluing them. These specifically are 10 premier properties located in upscale areas, like Key West, Napa Valley, Seattle’s waterfront and Washington, D.C.

Business is indeed booming in the hotel sector in general and at Prime’s properties, where RevPAR (revenue per available room) rose 9% in the last quarter, earnings rose 10.5%, and AFFO (adjusted funds from operations) rose 33%.

Hotel values are judged by what is called “cap rates.” In the private market, we are seeing cap rates of 6.5%. Ashford Prime’s cap rate is about 9.5%. Thus, the denominator of the ratio – property asset value – is higher in the private market than in the public market.

Thus, if the hotels were valued at that same rate, the stock should be trading close to $27, almost a 100% increase from current prices. Management is seeking a buyer for the company.

A Specialty Lender

I love specialty finance, and that’s why I love Credit Acceptance (NASDAQ: CACC). Most of the time, lenders have to deal with defaults from borrowers, which can devastate their bottom lines, even if the vast majority of their portfolio is performing.

With Credit Acceptance, however, that risk is somewhat mitigated. The company primarily advances money to auto dealers that offer consumer financing programs, and in exchange gets the right to service the underlying loans. They also get to keep some of the income from borrowers.

The company carefully packages groups of loans together, and because they are backed by a hard asset (cars), they can then offer these as securitization financings. That means they can put up the entire set of auto loans, and get money loaned against that collateral, in exchange for paying just a small portion of the interest earned by the portfolio. Then they can use that money to advance to other dealers.

This $4 billion company has room to run. It generated $380 million in free cash flow in the past twelve months and $290 million in net income. Companies like this should trade at 13-15 times free cash flow and Credit Acceptance only trades at a 10x multiple.

A Debt Collector

In a similar vein, we have PRA Group (NASDAQ:PRAA), which is a debt collector. It buys up portfolios of bad debts for pennies on the dollar, and collects more on them than they paid. It has been aggressively buying foreign collection firms and expanding its reach.

This business has outstanding returns on capital. It is growing at 15% per year, but will eventually hit 20%, once concerns pass regarding the CFPB and whether it will impose further regulations. The company is big on compliance, so I see little risk. The stock has been stuck in a trading range and is at $54. This is a $70 stock at minimum, and I think is worth closer to $90.

This article is brought to you courtesy of Lawrence Meyers from Wyatt Investment Research.

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