6 Small Cap Stocks with Deep Margin of Safety

Margin of Safety is a core concept in value investing. This essentially tells you how much the stock price is discounted from the intrinsic (or fair) value.

Margin of Safety serves two separate purposes.

1. A larger margin of safety means that the stock is already way below its fair value. Perhaps the market has overreacted to a bad news or perhaps there is too much pessimism in the market about the prospects of the company. Either way, the risk of the stock declining further is now less than it would have been, say, if the stock was selling at above the fair value. A large margin of safety typically implies less risk of loss of your investment.
2. It can be reasonably argued that the stock price will eventually reach the fair value. Therefore, the size of the margin of safety indicates the expected returns if and when the stock appreciates to its intrinsic value. Many value investors will sell the stock that becomes fairly priced but there is no hard and fast rules about this. You are welcome to hold on to the stock as long as it continues to show you incremental profits.

Given the importance of margin of safety in managing risk and estimating the target sell price, it is clear why stocks with high margin of safety are so desirable to a value investor.

The following screen is run using the Stock Rover’s Margin of Safety filters. Stock Rover calculates Margin of Safety using DCF analysis with their estimates of the future cash flows.

The Stock Rover Margin of Safety Screen

Small Cap - Margin of Safety
Screen to find the 50 stocks that have the greatest margin of safety based on their computed fair value relative to their price.

Criteria:
 Margin of Safety > 30
 Margin of Safety (Academic) > 30
 Margin of Safety EV to Sales > 30
 Market Cap ($M USD) > 30 < 2000

Rankings:
Highest  Margin of Safety  40%
Highest  Margin of Safety (Academic)  30%
Highest  Margin of Safety EV to Sales  30%

We are looking for a ranked list of stocks with highest margin of safety and we only look for stocks with margin of safety above 30%.

Here are the results:

Of these 6 stocks we have 2 energy companies and 2 media/broadcasting companies. This indicates that certain sectors may be on sale even as the rest of the market appears to be very richly valued.

Below I will take a brief look at each of these companies and jot down my impressions. If there are any stocks that appear to be especially interesting, I will add it to my watchlist and then do a deep dive. Please do not buy any stocks without conducting a thorough due diligence of your own.

GTN – Gray Media

Gray Media Inc is a multimedia company. The company owns and operates local television stations and digital assets. The traditional price multiples are extremely low: P/E ratio at 3.6, P/S at 0.2 and P/B at 0.3. There was a time when we expected the traditional media to be on its way out, replaced with digital media and entertainment. Well, a number of the traditional media companies adapted to the digital landscape. Last year we invested profitably in Tegna, which is now being purchased by Nexstar. So there is still a lot of life left in media companies and GTN seems to be in a good space where it may eventually get purchased and consolidated into a larger operation.

We own GHC in our Inner Circle portfolio and have been very happy with it. I may not want to add GTN to the portfolio buy I do want to take a look at the business so I will schedule a deep dive in the near future.

KINS – Kingstone Companies

Kingstone Companies Inc is a multi-line regional property and casualty insurance holding company. It offers insurance policies to small and mid-sized businesses as well as to individuals. It is selling at 2 times book value which is more than I would like to pay for an insurance company. Pass.

DEC – Diversified Energy

Diversified Energy Co PLC is an independent energy company focused on natural gas and liquids production, transportation, marketing, and well retirement, predominantly located within the Appalachian and Central regions of the United States. The company has not been profitable in the recent years and with the oil prices on the decline and OPEC production expected to stay high, the potential for profit here is very low. Pass.

FBRT – Franklin BSP Realty Trust

Franklin BSP Realty Trust Inc is a private real estate investment trust that originates, acquires, and manages a diversified portfolio of commercial real estate debt, and first mortgage loans. secured by properties located in the United States.

I do not invest in mortgage reits as I do not feel the risk is worth the reward. This is especially true as the credit scores across the board are rapidly falling and household financial stresses are increasing. Pass.

EE – Excelerate Energy

Excelerate Energy Inc offers LNG solutions, providing integrated services along the LNG value chain. The stock appears to be fairly valued based on the trailing numbers but the earnings are expected to rise 40% next year and sales to increase about 32% next year. Interesting to see why this could be the case, so I may spend some time on this. Adding to the watchlist.

SBGI – Sinclair

Sinclair Inc. is the owner-operator of the second largest portfolio of television stations in the United States, with 185 full power stations in 86 markets, covering 40% of US households. At 16 times earnings, the stock appears to be expensive compared to the peers. Pass.

We discarded 4 out of 6 stocks from the Margin of Safety screen. This is not surprising when you consider that the margin of safety has been calculated using a DCF analysis. Some value investors swear by DCF, I do not pay much attention to it, as your results are only as good as the assumptions that go into the model, and future earnings estimates are conjectures and not indicative of how the future will eventually unfold. So, while this is a good screen to uncover some potential ideas, you should still use your own judgement to filter the stocks further.