Focusing on companies that are statistically cheap, generate prodigious amounts of free cash flow and possess catalysts for improved operating performance that are not properly discounted by the market helps investors avoid value traps in small-cap investing, says Richard A. Giesen Jr., Founder and Chief Investment Officer of Elessar Investment Management.
“We have a dual mandate for the companies we want to own. They must be growing their enterprise in tandem with the appropriate capital structure, so a company that has been successful in meeting these objectives will be financially productive in terms of generating an attractive return on capital,” he said. “We have found the free cash flow yield to be the best indicator of future performance of a company’s stock throughout a market or economic cycle.”
Giesen likes ValueClick, Inc. (VCLK), a technology company that provides online marketing services including advertising exchanges, targeted display ads and mobile advertising. He says he expects the online advertising market to grow mid-double digits in 2012, as it takes market share from print and radio. Giesen bought the stock in 2010 at a price of $11.25, and currently the stock price is above $20. He believes ValueClick shares should trade in the mid-$20s, despite giving it a discount to its peers.
“We like the strong free cash flow generation of the company, which in turn enables them to invest in R&D and acquire complementary technologies. The company’s recent acquisitions have been very timely, especially their acquisition of Greystripe, which gives them a beachhead in the next leg of growth in online advertising, mobile advertising,” Giesen said.