Big opportunities in small places (Jewett Cameron)

February 4, 2010

They do say that small cap companies, which are not commonly followed by Wall Street analysts or even portfolio managers for a variety of economic reasons, are a fertile hunting ground for underpriced stocks. Although this effect has somewhat diminished since it was discovered, as most facts on Wall Street inevitably are (apart from the success of value investing itself, of course), it is generally the case that the more interest there is in a particular class of assets, the more efficient the price becomes. For an exception to this rule, see the pricing of subprime mortgage derivatives.

I have also been considering foreign stocks in the same light; the United States financial system is widely considered the most robust in the world, and as such we are very good at sniffing out wrong prices. It therefore follows that in foreign nations the markets are less efficient and therefore riper grounds for opportunities. Of course, a lot of this could spring from the possibly low state of development of overseas capital markets and accounting/financial reporting rules.

At any rate, there are problems with investing in small companies, primarily having to do with how easy it is to distort prices with smaller orders. My favorite stock screener includes many stocks that have market caps of under $50 million and several stocks that have days where not a single share is traded, at least on the U.S. exchange. One such stock is a quirky little company called Jewett Cameron (JCTCF), which operates in British Columbia but apparently reports in American, and for which at current prices $14 million would buy the entire company.

And $14 million probably should buy the entire company, although it would have to go to Canada to buy a lot of the shares. Despite its small size, the firm has four operating segments: industrial wood products; lawn, garden, pet, and other; seed processing and sales; and industrial tools and clamps. Sales have been declining lately, largely as a result of a sharp decline in the industrial wood products division due to the slowness of the boating industry. The firm has also had to write down a large amount of its grass seed inventory last quarter as a result of slowness in demand from new homes and golf courses, which are apparently two large users of grass. Nonetheless, the firm remained profitable last quarter despite this large writedown and the seasonal slowdown in its business. Based on historical earnings power, the firm trades at a price/earnings power of 7, although if the boating market does not recover and the firm can find no alternate use for its boating-grade wood, historical earnings power may not be useful as a permanent guide.

On the balance sheet side, the firm has in current assets $7.6 million in cash, $2.2 million in receivables, and $6.8 million in inventory, total $16.9 million. There are an additional $909 thousand in liabilities, making this stock positive on a net-net working capital basis, although a large inventory writeoff would put that situation at risk. The firm’s overall price/book ratio is 0.79, and its large cash position suggests that their return on noncash assets is attractive; I estimate it at a pretty decent 11%.

So, Jewett Cameron is a stock worth considering in the (very) small cap arena. Just make sure you buy slowly and carefully.

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