Small companies typically outperform over time because they have greater growth prospects than the market leaders.
Between 1927 and 2012, for instance, small caps produced annual returns of 12.9%, compared with 9.9% for large companies. Even now, when many indices have hit highs, the S&P 600 Small Cap Index has gained 31%, in the past year compared with a 23% gain for the S&P 500 over the same period.
But most retail investors shy away from small caps mainly because they perceive them to be part of the seedy underbelly of investing, the world of pump-and-dump boiler rooms. That reputation is not entirely undeserved. Many illiquid companies exist whose financials are at best an educated guess.
So to find small-cap stocks that could be assumed to be reasonably safe investments, I used a several-step screening process, starting with solid fundamentals and substantial insider and institutional ownership.
Among companies with market caps of no more than $90 million, I found 23 that had positive returns on equity and assets, a forward price-to-earnings (P/E) ratio, and institutional and insider ownership of at least 10%.
*of those with dividends
I compared the one-year returns of these stocks with the S&P 600 Small Cap Index. Any stock that had crossed below the index and was trending down was dropped, which left me with six contenders — three of which paid dividends. Like many investors, I have a bias toward stocks that pay dividends, so let’s look at those.
What I found were three companies which each have been on a solid growth trajectory.
Acme United Corporation (NYSEAMEX:ACU) is a global supplier of cutting, measuring and safety products to consumer and industrial markets. It has neatly tracked the S&P small-cap index and shown the least volatility of the three stocks. While its $43.7 million market cap is the lowest of the three, its nearly $14 share price is the highest. It has a forward P/E of 9.2, and its dividend yield is the best of the three at 2.3%. In its most recent quarter, Acme United Corporation (NYSEAMEX:ACU) posted a 7% increase in net income and a 3% rise in earnings.
On the institutional side, North Star Investment holds nearly 400,000 shares and has made more than a dozen insider purchases this year. Acme United Corporation (NYSEAMEX:ACU)’s CEO, Walter Johnson, did sell 8,000 shares this month, but he still holds more than 350,000 shares.
Eastern Virginia Bankshares, Inc. (NASDAQ:EVBS) is a bank holding company. It received $24 million in financial bailout funds, but it’s been released from its agreement with regulators because it raised enough money through private placement. Its $66.7 million market cap puts it in the middle of the group, although its share price is currently the lowest at just over $6. It has a forward P/E of 9.2, but its 1.1% dividend yield is the least of the three. Net income and earnings were down for the most recent quarter, mainly on charge-offs for non-performing and uncollectible assets and other losses.
Eastern Virginia Bankshares, Inc. (NASDAQ:EVBS)’ management and directors have been on a spree buying back stock this year, including 19 transactions in June alone at $4.55 a share — nicely timed before the company said it had been released from its Troubled Asset Relief Program (TARP).