Red October: Forbes Best Small Cos (2013)

It’s that time of year again. Red October. Some people refer to small company stocks as Red Chips and we take our annual look at one of our favorite shopping lists — a tradition that has bagged a number of extremely rewarding investments over the years.

Forbes is out with their annual list of spooky small companies, the Best Small Companies for 2013.

This year’s headliner is Questcor Pharmaceuticals (QCOR). Questcor is among eleven healthcare companies in this year’s list. Acthar is the company’s main drug, used in the treatment of multiple sclerosis, infantile spasms and rheumatic disorders. The drug accounted for the bulk of QCOR’s annual sales total.

The companies featured at the top of Forbes list are:

1. Questcor Pharma (QCOR)
2. Grand Canyon Education (LOPE)
3. Proto Labs (PRLB)
4. Invensense (INVN)
5. Sturm, Ruger (RGR)

We’ll audit, confirm, study and whittle the list down to identify our favorites and see how they compare.

But these potential future titans don’t have to be scary. As we’ve hunted down buying opportunities from this annual listing over the last several years, we’ve discovered that the best returns tend to come from the entrants with the highest quality ratings.

Dashboards Past

We obviously still like to talk about the companies featured in 2008. These are the selections we bring up at the hair salon or barber shop. There are lessons to be learned (and celebrated) in companies like Neogen (2006), DXP Enterprises (2007), Stratasys (2008), Middleby (2008), Dril-Quip (2008), Boston Beer (2008), Bio-Reference Labs (2008 & 2011), Buffalo Wild Wings (2007-2011), Carbo Ceramics (2012), FactSet Research (2008), Mesa Labs (2012), NIC (2012), Peet’s Coffee (2009), Portfolio Recovery (2007,2010-2011), SolarWinds (2011) and SS&C Technologies (2012).

We note that Bio-Reference Labs (BRLI) is now the second most widely-followed company by MANIFEST subscribers, having first appeared on this list back in 2008.

It’s interesting to see Grand Canyon Education (LOPE) near the top of the list because of the damage done by the likes of from the educational services stocks like Strayer and Capella in recent years … and Quality Systems (2006-2008,2010-2011) — a multiple selection that’s done considerable damage to the all-time results.

It’s been a good year for our Forbes Best Small Company tracking portfolios. All in all, the outperformance accuracy is 51.4% and the relative return since 2006 is +2.3% (17.4% vs. 15.1%).

Halloween: Our Cue To Haunt Some Studies

Ken Kavula noticed that Forbes had released the 2013 listing earlier this week. I hope you’re not surprised that Ken is all over this as one of our favorite small company advocates.

So we start whittling with all 100 thanks to Ken:

We’ll require a minimum growth forecast of at least 10%, a quality ranking of 80 or better, and a return forecast greater than 11%. The screening results will be maintained here:

Here’s the results of auditing the 100 candidates … a short list of companies with small company growth characteristics, exceptional quality … that appear to be attractively priced.

The difference between tricks and treats? Quality.

Value Line Low Total Return Screen (9/27/2013)

Not Much To Write Home About

For the first time in recent memory, there are no “materially weaker” companies in this week’s roll call. But before launching into celebration and exuberance, there’s not many “materially stronger” companies on the list … and the downward adjustments, albeit lower in magnitude … still manage to deliver a slightly lower overall return forecast for the group. There were slight reductions in the long-term forecasts for a number of home builders, including the likes of Pulte (PHM) and D.R. Horton (DHI).

The issue 6 update is usually a little more stable — as the outlook and fundamental characteristics of steady, reliable companies like Procter & Gamble (PG), Kimberly Clark (KMB) and Colgate-Palmolive (CL) are always less volatile.

In the words of 2012 Groundhog Champion, Bernie Meister, “it’s about time that these research agencies upped their outlook on Lumber Liquidators.”

At the same time, the average price-to-fair-value ratio at S&P for the companies in this week’s update batch is 110%. So if you’re going to shop among them, shop well.

Companies of Interest

Materially Stronger: Covanta Holding (CVA), Lumber Liquidators (LL)

Materially Weaker: None

Market Barometers

The median Value Line low total return forecast (VLLTR) sagged slightly to 4.3%, down from 4.4% last week — and continuing to hover near historical lows.

The Wilshire 5000 continues its march to new highs. Remember … the relative strength index (RSI) is signaling potentially overbought at RSI>70 — but can stay in this condition for a very long time. Momentum is still solid with the average stock up 22% over the last nine months. Continue to shop for high-quality with sufficient returns as protection versus the next correction, recession and/or bear market.