Unfortunately, we sometimes miss some real winners. However, an autopsy of missed alpha can be instructive and help us refine our stock rating process and potentially challenge our team to acknowledge selection bias when appropriate.

Individual investors may have different risk tolerances and industry knowledge which essentially could override our rating decision. Our goal is to provide comprehensive and balanced research replete with information and opinions that enable informed investment decisions.

Additionally, no stock screener is fool proof, but it still provides value as a “first cut” process for sorting out potential winners. Even with the advances in AI, which have accelerated the stock research process and provide detailed pros and cons, stock picking will still ultimately rely upon some human judgement call for those who subscribe to active vs. passive investing.

We felt it worthwhile to evaluate a rich example of a missed opportunity, in this case, SIFCO Industries, Inc. (SIF Quick QuoteSIF - Free Report) .

Image Source: Zacks Investment Research

We launched coverage in February of 2025 with a Neutral rating. The stock was trading at about $3.60/share. SIFCO Industries, Inc. (SIF Quick QuoteSIF - Free Report) provides forging and machine components primarily to the aerospace and defense industries. Exposure to the highly cyclical aerospace industry probably raised our risk antennae. And defense industry orders can be lumpy due to the procurement process.

Timing the turn-around and picking the bottom in a historically cyclical industry is inherently difficult, in my opinion. But what did the data suggest?

The latest quarter, Q4 of 2024, which ended 9/30/24, was improved with EPS loss narrowing to ($.33) vs ($.53) in the prior year. Adjusted EBITDA had also turned positive at $.8 m vs. ($1.5 m) in the prior year.
Q4 sales increased 14% YOY and backlog increased 17% YOY as well. 

Although management did not issue formal guidance for FY25, it did mention it was preparing to increase production based on customer demand.

The valuation at the time was reasonable, trading at about a 30% discount to Book Value and slightly less to Tangible Book Value. However, the business was still unprofitable, suggesting book value could continue declining, albeit at a lower rate.

The 5-year valuation analysis suggested the stock had traded as low as a 70% discount to Book Value so more downside was possible.

While Gross margin was improved at 7.5%, that was still relatively low, especially on a Marx ratio level (Gross Profit/Total Assets), so the stock was screening near the bottom of the microcap universe.

While debt had been materially reduced due to the divestiture, the rate on the revolver had increased to 9.8% vs. 8% and operating cash flow was barely positive for the FY, so interest rate exposure was an additional risk factor if the company was forced to draw on the revolver.

The company remained unprofitable, although less negative, for the next 2 quarters accompanied by backlog growth and some sales growth. However, the Gross Margin remained subdued at sub 6% so material leverage was still absent. Additionally, our ranking system was flashing Underperform because of the low Gross Margin. 

So, we remained on the sidelines. It appeared our initial assessment was prudent.

But then the calendar June 25 quarter came along, and the company generated EPS of $.54 vs. a loss of ($.16) in the prior year, benefiting from a one-time ERC (Employee Retention Credit) of $2.4 m which positively impacted Gross Margin, raising it to nearly 27%. Absent the credit, Gross Margin would have been about 15.8%.

But sales were flat for the quarter, casting doubt on cyclical recovery while potential exposure to new 50% tariffs on aluminum and steel loomed. Additionally, the cash balance remained relatively low at $1.9 m and interest rate exposure on the revolver remained a concern. Hence, we remained on the sidelines, but the stock essentially doubled to $7 on the suggested profitability turn-around.

I heard echoes of when back in the day I would occasionally run into an IR person at an investor conference and they would say, “Our stock is now at $7. Where were you at $3.50 when I introduced you to the name?” 

The stock maintained support around $7 for the next 2 quarters and valuation consequently rerated to about 1.2x Book value. Tariff impacts still loomed and we remained unconvinced regarding the durability of structural gross margin improvement. The strength of the aerospace and defense vertical recovery were also concerns.

But then the company reported calendar quarter ending 12/31/25 and the stock quickly doubled again to around $14. In that FY-Q1 sales grew 14.8% while backlog also increased YOY by 14%. But perhaps most importantly, Gross Margin improved YOY to 21.6% vs. 4.4% enabling EPS to grow to $.29 vs a loss of ($.40) in the prior year. Gross margin increased due to higher throughput, favorable pricing and mix shifts from exiting lower-margin work.

By now the stock had re-rated to 2.3x BV. So, we missed it. And the stock was trading at 5-year valuation highs so we just couldn’t pull the trigger, though the stock would double once again to $28+ before pulling back more recently.

This stock was very reminiscent of another microcap, Perma-Pipe International Holdings, Inc. (PPIH Quick QuotePPIH - Free Report) , which we’ve highlighted in previous articles. Similarly the company was exposed to cyclical and lumpy markets while trading at an attractive discount to Book Value.

Image Source: Zacks Investment Research

In the case of Perma-Pipe International Holdings, Inc. (PPIH Quick QuotePPIH - Free Report) , however, we felt more comfortable with the topline catalysts. And the business was profitable. That Outperform worked well after we launched coverage in May of 2024.

The point of this exercise is multi-fold. Firstly, we wanted to demonstrate more specifically our thought process as we monitor stocks after initiation. A constant process of weighing multiple factors is at play. Secondly, as we’ve written about previously, microcaps as an asset class are very volatile, on the magnitude of about 2x vs. large caps. And hence, valuations can re-rate significantly in quick order.

One could argue that perhaps we were too risk averse by fixating too much on Gross Margin, ignoring a possible margin of safety with the backlog increase and the attractive discount to tangible book value. 

But perhaps the most valuable lesson is that investors should not easily dismiss Neutral rated stocks, they too can produce significant alpha and are worth studying.