Small cap investing is fun, rewarding and quite interesting. As Warren Buffett once mentioned that he would confidently deliver 50% annualized compounded returns if he managed around $1 million. His partner, Charlie Munger said if we wanted success, we should go to where we did not have any competition. That is true. The key is to invest in small, profitable businesses, which haven't been spotted by any radars or covered by numerous analysts on Wall Street. However, investors need to be very patient, because sometimes it takes years for the stock to move, and sometimes several opportunities are quite illiquid. In this small-cap opportunitiesseries, I will present small cap ideas suitable for investment.
This business is a specialty retailer of home appliances, consumer electronics, mattress, computers, etc. It has been in the business for 57 years, operating 208 stores in different states in the US. The company differentiates itself from other home appliance retailers by giving the customers’ educational shopping experience and next day delivery services. The name of the retailer is hhgregg (NYSE: HGG). Over the past 10 years, HGG has managed to increase its revenue and profits gradually.
For the past 10 years, its revenues have grown from $617 million to nearly $2.5 billion, marking a 15% compounded annualized growth. Its net income was $25 million in 2003. It was $81 million ten years later, marking an annualized growth rate of 12.5%. In the same period, HGG has reduced its number of shares outstanding from 60 million in 2003 to only 36 million this year.
In terms of profitability, since 2008, the retailer has delivered a double-digit return on invested capital. In 2012, the ROIC was more than 25%, increasing from 13.17% in just 5 years.
Net Margin (%)
In the last 5 years, HGG has managed to perform several improvements. It has increased its net margin to the highest level of 3.26% in 2012. Along with the improvement in net margin, the asset turnover fluctuated but reached the highest level in fiscal 2012 too, of 4.18x. The decreasing trend in its ROE was due to the reduction in financial leverage over time.
Operationally, the retailer still had a continuous decrease in its comparable store sales. However, the decrease has been gradually narrowed down, from -8.3% to only -1.1%.
Comp sales growth (%)
Cash conversion cycle
The cash conversion cycle (CCC) is a ratio, which tells investors how many days it takes a retailer to convert its payables, inventories and receivables into cash. The lower the ratio is, the better. The higher CCC in 2012 was mainly due to lower payables period. So the retailer needed to pay its suppliers quicker.
At this time of writing, HGG is trading at $8.11 per share. The total market capitalization is $280.61 million. The market is valuing HGG at a cheap earnings multiple, of only 4x P/E, which is only a third or less of its average historical valuation.
It is quite a tiny retailer compared to its other competitors such as Best Buy (NYSE: BBY), and Wal-Mart (NYSE: WMT). However, HGG’s operating figures are far more superior. Trailing twelve months, Best Buy is currently delivering a loss while trading at 50% of its book value, but it offers its shareholders a 4.3% dividend yield. Wal-Mart had a net margin of 3.53%, delivered a return of 13%. It pays investors 2.2% dividend yield. The market is valuing Wal-Mart at 15.2x P/E.
My Foolish Take
From all operating and profitability numbers, HGG seems to be a screaming buy for long-term and patient investors. Personally, it could be a buy for me. However, investors need to see whether HGG is suitable for themselves, and for their portfolios as well as their liquidity needs before initiating a position in this retailer.