Everyone, it seems, wants to invest like Warren Buffett. There are dozens of books devoted to investing like him. There are seminars and reports that outline his investing secrets. Investing like Buffett is a cottage industry.
But there's a dirty little secret that is never talked about.
Even Buffett doesn't invest like Buffett anymore.
In the last decade, as the size of Berkshire Hathaway has swelled, even Mr. Buffett has admitted that his investing style has changed from his younger years, when Berkshire was smaller and more nimble.
Now, the company has so much cash, that investing in the $200 million small cap South Korean car manufacturer, which he could have done in the 1970s, just isn't as feasible unless Berkshire buys the company outright. Investing a couple of million here and a couple of million there, just doesn't get it done.
Instead, Berkshire now has to invest billions.
As a result, the company now owns large stakes in the largest companies in the world such as IBM, or more recently, Apple.
None of these investments are groundbreaking or unique. They also aren't going to get Berkshire the returns of the kind it got in the 1970s and 1980s when it could invest in more small and mid-cap names.
It's the small and mid-caps that have the higher growth rates.
Buffett Wishes He Could Go Small
In 2005, Buffett met with student groups from Kansas and Texas A&M. This is what he said about investing with a small amount of money:
Question: According to a Business Week report published in 1999, you were quoted as saying "it's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that."
First, would you say the same thing today? Second, since that statement infers that you would invest in smaller companies, other than investing in small-caps, what else would you do differently?
Answer: Yes, I would still say the same thing today. In fact, we are still earning those types of returns on some of our smaller investments. The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts.
It would perhaps even be easier to make that much money in today's environment because information is easier to access.You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map - way off the map.
You may find local companies that have nothing wrong with them at all. A company that I found, Western Insurance Securities, was trading for $3/share when it was earning $20/share!! I tried to buy up as much of it as possible. No one will tell you about these businesses.
Finding Small Business That Have Great Fundamentals
It's easy to "find" the IBMs and Apples of the world. Every investor knows about them.
But how do you find those unknown small cap companies that aren't on everyone's radar? And how do you know they have solid fundamentals?
This is the perfect situation in which to deploy the Zacks Rank. If you screen for Zacks Rank #1 (Strong Buy) and #2 (Buy) stocks, with market caps under $1 billion, that eliminates thousands of companies.
It will produce a list of companies with rising earnings estimates.
But don't stop there.
If you're going for the best, why not get it cheap?
I screened for companies with P/Es under 15 and P/S ratios under 1.0. A P/S ratio under 1.0 usually indicates a company is undervalued.
The average P/S ratio for the S&P 500 right now is 2.7.
I also looked for growth. If it didn't have it this year, then I looked for companies that will see bigger growth in 2017.
The result is these five small cap companies that Warren Buffett, if it was 1976, might have taken an interest in.
5 Small Caps That Buffett Wishes He Could Buy
1. SPX Corporation (SPXC - Free Report)
SPX supplies highly engineered HVAC products, detection and measurement technologies and power equipment in 20 countries. It is headquartered in North Carolina.
It has been selling slower growing segments and consolidating. It's Base Power segment continues to be its largest. On May 5, it reaffirmed full year guidance.
Forward P/E = 13.1
P/S ratio = 0.3
Market Cap of $621 million
2016 EPS expected growth = 140%
Zacks Rank #2 (Buy)
2. Delta Apparel Inc. (DLA - Free Report)
Delta Apparel makes lifestyle basics and branded activewear apparel and headwear to specialty stores, boutiques, department stores, mid-tier and mass chains and the US military. It sells under the Delta Apparel brand as well as M.J. Soffe, Junkfood Clothing Company, Salt Life and Art Gun.
It has plants in the United States, Honduras, El Salvador and Mexico.
Forward P/E = 13.5
P/S ratio = 0.4
Market Cap of $165 million
2016 EPS expected growth = 321% with another 25% expected in F2017
Zacks Rank #1 (Strong Buy)
3. AV Homes, Inc.
AV Homes builds active adult and all-ages residential communities in Florida, Arizona and the Carolinas. The housing markets in those states have been hot and that is reflected in AV Homes' rising revenues and closings.
Homebuilding revenue rose 127% in the first quarter as the number of homes closed doubled and the average selling price jumped 13% to $283,000.
Forward P/E = 10.2
P/S ratio = 0.4
Market Cap of $278 million
2016 EPS expected growth of 124%
Zacks Rank #2 (Buy)
4. Salem Media Group (SALM - Free Report)
Salem is one of the largest multimedia companies specializing in Christian and conservative content in the United States. It operates in radio, digital media and book, magazine and newsletter publishing.
It operates 116 local radio stations with 71 of those in top 25 media markets. It also runs a full-service national radio network with syndicated programs including Bill Bennett, Mike Gallagher, Dennis Prager and Eric Metaxas.
Salem also recently acquired the King James Bible mobile application.
With national elections this year, which means lots of political ad buying on radio stations, Salem is poised to cash in.
It also pays a dividend, currently yielding a very attractive 4.1%.
Forward P/E = 13.3
P/S ratio of 0.6
Market Cap of $159.5 million
2016 EPS expected growth of 9.3%
Zacks Rank #2 (Buy)
5. Tower International (TOWR - Free Report)
Tower is a Michigan based manufacturer of engineered automotive structural metal components and assemblies.
It was looking at selling its European, Brazil and Chinese businesses but it decided to maintain Tower Europe as it now sees new business opportunities with that division. Brazil and China will no longer be considered core and are being held for sale.
"Following 23 consecutive quarters of meeting or beating the earnings consensus, Tower's businesses in Europe and North America are now poised to deliver record results, including double-digit earnings growth and strong free cash flow." said CEO Mark Malcolm on Apr 28.
Forward P/E = 6.4
P/S ratio of 0.2
Market Cap of $427 million
2016 EPS expected growth of - 2.6% but expected to rebound in 2017 by 14.5%
Zacks Rank #2 (Buy)
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Tracey Ryniec is the Value Stock Strategist for Zacks.com. She is also the Editor of the Insider Trader and Value Investor services. You can follow her on twitter at @TraceyRyniec and she also hosts the Zacks Market Edge Podcast on iTunes.