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.

View From The Top Shelf

Sweet 16: Screening Results (March 2013)

This month features the top percentile of all stocks covered at MANIFEST on the basis of quality (our combination rating of financial strength, earnings stability and relative growth and profitability forecasts). It’s not the customary sixteen stocks or so … but these twelve quality champions are formidable and worthy of a closer look and automatic/perpetual pounce pile status.

Overall Market Expectations

The median projected annual return (MIPAR) for all 2400+ stocks followed by MANIFEST (Solomon database) is 7.2% (2/28/2013). The multi-decade range for this indicator is 0-20% and an average reading since 1999 is 8.5%.

Companies of Interest

With the median return forecast hovering at 7.2%, less than the historical average and nearing historical lows, it makes sense to shop on the top shelf. If prices continue to surge absent any strengthening of fundamentals, the return forecast could get significantly lower. The subtle whittling of expectations (no slashing) continues as we begin the first quarter updates for 2013. Invest in the best (highest quality) but only when they’re suitably on sale.

The top shelf company with the highest fusion rating (combination of fundamental and technical analysis scoring) is Cognizant Technology (CTSH). Cognizant is well-positioned within its industry with a strong track record and stands to benefit as the global recession turns to recovery.

Mesa Labs (MLAB) continues to score well and is one of our favorite companies from this year’s batch of promising small companies from Forbes.

The recent price swoon in Coach (COH) leaves the company with the lowest price-to-fair value ratio (76%) from Morningstar and Standard & Poor’s (83%) among the companies on the top shelf. The price reduction also generates an annualized low total return forecast of 16.4% at Value Line. There’s a rumor floating that somebody thinks all of the purses are a bit pricey … but those crowds of trampling shoppers and a legacy of results suggests that the whole company might be worth buying. I don’t think the price tag hanging on the company is $40-something.

Those return forecasts across the board look pretty good on the top shelf … not a bad idea to start there.

10. Mesa Labs (MLAB)

The third company in our annual stock selection countdown is a relative newcomer to most of us — but a company that we’ve featured on multiple occasions.

Taxes on investments are (1) going up if Republicans and Democrats decide to agree on something or (2) if they continue to disagree across the board and over the cliff. In other words, taxes will increase on dividends and capital gains. One of the effects that we’ve been seeing for a while now is the traditional January Effect. The selection of Mesa Labs (MLAB) gives us a chance to reinforce a message that is always a good idea this time of year — and this year even more so.

We recently discovered MLAB through the annual publication of the Forbes Best Small Companies a couple of weeks before Halloween. It’s one of our favorite troves and you can read more about it here

It’s not unusual for the smaller companies to be more deeply impacted by tax-related selling during the final quarter of the year … leading to an event-driven opportunity to sell (when appropriate) all the while waiting to pounce on the ON SALE NOW opportunities created by the price swoons.

And quality matters. If we’ve learned nothing from watching the performance of these faster-growing companies over the last decade, it’s that we want to be vigilant for the leaders. We recognize them by steady, consistent growth and profitability patterns and balance sheets (financial strength) that are often a cut above their agile emerging peers. Last year’s favorite, SolarWinds (SWI) is up 130% over the last twelve months. We like that.

Mesa Labs (MLAB) was also featured as a recent monthly stock selection for December 2012

We also know that balancing the overall growth forecast FOR ANY PORTFOLIO is a really good idea … and after the selections of CVS and JW-A, MLAB provides a healthy boost in this regard.

Christmas Countdown Dashboard:

Christmas Countdown (2013)

It’s hard to believe that 2012 is winding down. And with the Wilshire 5000 (VTI) up approximately 15% YTD, it’s time to take a look back at the selections we made during the 2012 Christmas Countdown. Bottom line: The nine selections have a positive relative return of +4.2% and an out performance accuracy of 67%. Santa, we’ll take that.

With a positive relative return of +2.2% for the 2011 selections (and an out performance accuracy of 58.3%) we’ll knock on wood — celebrate the positive outcomes — and start the hunt for stocking stuffers for this year’s countdown.

Christmas Countdown (2013)

Dashboard: 2013 Countdown Stocks