Although the mid-year rally has been taking a breather lately, we’re in a new technical bull market.
That means indexes have risen 20% from their bear market lows (October 2022 for large-cap stocks). And as you’ve no doubt seen, most of those gains are attributable to the “Magnificent 7” mega-cap tech stocks.
At the midway point this year, the 10 largest stocks represented 31.7% of the market capitalization in the S&P 500.
But those 10 largest stocks are quite expensive and represented just 21.5% of the S&P 500’s earnings.
I don’t want to fight the tape, but it’s also hard for me to chase the rally.
The U.S. looks expensive.
In particular, the largest stocks look the most expensive.
And we know that large-cap stocks have historically underperformed their smaller counterparts.
So the obvious alternative is to buy small and micro-cap stocks.
Usually, when you buy “cheap” stocks you have to sacrifice growth potential.
But that is not the case with micro-cap stocks.
Today I’m going to share 3 highly compelling growth companies that are being undervalued by the market.
3 Undervalued Micro-Cap Growth Stocks
IDT Corp (IDT)
IDT Corporation is a mini-conglomerate run by Howard Jonas, one of the best value creators in the world.
IDT’s strategy is very similar to IAC’s. It uses the cash flow that its legacy telecom business to create and nurture new businesses. Once those businesses are mature, they are set free I the public markets.
Since 2009, IDT has spun off 5 subsidiaries and has created billions in shareholder value.
The company is incubating two rapidly growing businesses: National Retail Solutions and net2phone.
National Retail Solutions is a point-of-sale network with 23,000+ terminals.
The target customer for the point-of-sale terminals is the owner of a convenience store. The terminal will help the customer more efficiently manage his/her store.
NRS is EBITDA positive and has grown recurring revenue at a 113% CAGR over the past 4 years.
Net2phone is IDT’s other growth business.
It is also EBITDA positive and growing 20%+ on an annual basis.
Despite these high-growth assets, the stock trades at just 5.8x EBITDA.
Medexus (MEDXF)
Medexus is a specialty pharma company that just reported a blowout quarter.
Revenue grew 41% y/y while adjusted EBITDA grew over 100% to $4.8MM.
Despite phenomenal growth, the stock trades at just 7x forward earnings, an EV to forward revenue of 0.6x, and an EV to forward EBITDA of 3.8x.
Finally, insider ownership is high ensuring that shareholders are aligned with management.
What’s the catch?
The company has a convertible debenture that comes due in October.
If Medexus has to repay the debenture in shares, dilution will be significant.
Luckily, Medexus is generating significant cash and expects to have $20MM of cash available to repay the debentures and also has a credit facility for $20MM that it can potentially utilize. Finally, Medexus has been buying back its debentures in the open market.
2seventy bio (TSVT)
2seventy bio is a rare biotech.
It is well funded with over $300MM of cash on its balance sheet (no debt) and has a rapidly growing drug (+100% y/y) that could hit peak sales of $3BN.
Despite this attractive setup, the stock trades at just 1.7x revenue. Biotechs generally trade between 3x and 10x revenue.
I’m betting its cheap valuation won’t last for long.
An obscure tax rule in the U.S. prevents tax-free spin-offs (2seventy bio was spun out of bluebird bio) from being acquired for two years. 2seventy bio’s two-year anniversary will pass in November 2023, and at that time, I expect M&A rumors to heat up.
While it might be tough to find undervalued growth stocks in a bull market, I like the look of all three of these.
