Finding The Best Small Companies To Invest In
Jae Jun | Nov 27, 2012 06:12AM ET
Finding great ideas is difficult. If you are lucky, you’ll come across several a year, but there is a way to find more and better ideas.
One method that I always look forward to is finding the best small companies to invest in by scanning the annual , and reverse engineering the PE, the expected growth rate comes out to 25%.
The difficult question then becomes whether Solarwinds will be able to achieve this growth going forward and for how long?
I’m afraid, I’ll have to let you answer that one.
#2 Grand Canyon Education (LOPE)
Grand Canyon Education, Inc. is a provider of post secondary education services offering graduate and undergraduate degree programs in education, healthcare, business and liberal arts. The company offers online, as well as ground programs in Phoenix, Arizona.
Highlights
- Sales growth of 47%
- EPS growth of 236%
- ROE of 27%
- Increasing net margins annually
- Low debt
- Exponential increase in capital expenditures
- Current ratio is below 1 (but not at the risk of bankruptcy)
- Watch for accrual build ups
The capital expenditure values blue the free cash flow number too much to be of much help. What I mean by this is that in 2006, capex was recorded as $2.4m and in 2011, it was recorded as $80.5m. This growth in capex is unheard of. According to TTM figures, the capex currently sits at $20m which is far too low considering that the average capex over the past three years has been $60m.
Instead the better number would be to use owner earnings in the DCF stock valuation.
Performing the same reverse valuation exercise as before, a growth rate of 12.5% is required for the stock price to be valid based on
- discount rate of 12%
- starting owner earnings value of $66m
A reverse Graham valuation shows a required growth of only 6% if the analyst earnings of $1.50 is used in the calculation.
The Katsenelson Absolute PE shows that the current growth rate based on its PE is 13%, but the fair value is $27 which bakes in an expected 19% growth in the price.
#3 American Public Education (APEI)
American Public Education, Inc. is a provider of exclusively online postsecondary education with an emphasis on serving the needs of the military and public service communities. The Company operates through two universities: American Military University (AMU), and American Public University (APU).
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Highlights
- Sales growth of 44%
- EPS growth of 55%
- ROE of 35%
- Increased gross margins each year
- Zero debt
- Zero intangibles and goodwill
- Rising SG&A leading to lower net margins
- First time the Sloan Ratio has reached the warning level using TTM number
- Beneish score of 1.1 is a huge warning sign for earnings manipulation
Based on many valuation ratios alone, I am surprised that American Public Education came out to be number three on the list.
APEI should be categorized as a value stock based on the following numbers below.
According to the DCF valuation model, the expected growth is 17% which I find a little too high for this company.
From a different angle, using the Katsenelson Absolute PE model, the current expected growth rate is 10% from the stock price of $32.44 but the fair value comes out to be around $38 which means that the expected growth rate for the fair value is 14%.
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