These Small Caps Look Cheaper Than Your Tracker


LONDON -- Let me start by saying that FTSE 100 (INDEX: ^FTSE) index trackers can be great investments for many people. Such trackers can capture the performance of the benchmark index at low cost and give an easy opportunity to enjoy the potential future power of the stock market -- without the worry of individual stock-picking.

In fact, now does not look to be a bad time to back the market through an exchange-traded fund such as the HSBC FTSE 100. Standing at 5,676, the blue-chip index currently trades at a price-to-earnings ratio of 10 -- a multiple that is well below the average of 15 seen since the start of 2000.

That said, there are always shares that look an even better value than the FTSE 100 -- and I'm always scouring the market for low-P/E bargains that offer the chance of a "rerating" and could beat a tracker by a healthy margin. Here are three names I believe should outperform over time.

1. Bloomsbury Publishing
Bloomsbury Publishing (ISE: BMY.L) -- which now goes for 115 pence per share for a market cap of 85 million pounds -- made its name on the back of the Harry Potter phenomenon, so the snapshot view is that the publisher has had its day now that J.K. Rowling has hung up the young wizard's hat.

But such a lack of perceived growth opportunity means the company is valued at less than its net assets and has more than 75 pence per share in net working capital. Factor in a current P/E of 9.44, which is expected to fall further next year, and the price seems to make little sense. The P/E falls to eight against enterprise value (stripping out the cash). There's also a respectable dividend yield of around 4.8%.

Perhaps most importantly, Bloomsbury looks capable of steady growth from here, but this is certainly not reflected in the price. The company described 2011 as "transformational," as it acquired a leading academic publisher for 19.2 million pounds from its cash reserves and shed a loss-making German subsidiary. It also saw a huge increase in e-book sales of 159% to 5.7 million pounds and has invested heavily in digitizing its entire back catalogue, including young Mr. Potter.

It has since acquired a smaller publisher in Switzerland as it moves further into the more predictable area of academic publishing. I see steady growth and fundamentally good value here.

2. James Latham
It's a similar value with growth story at wood importer and distributor James Latham (ISE: LTHM.L) , whose final results for the year to the end of March 2012 were very encouraging. Latham made earnings per share of 31.9 pence on improved sales. The company put in this performance despite additional costs incurred due to the relocation of its biggest depot to a larger, modern site in Leeds.

The shares currently sit at 276 pence, giving the company a market capitalization of 53.11 million pounds. This year's anticipated earnings place the shares on a P/E of 9.9, falling further next year, while the expected yield of 3.6% is covered more than three times by earnings.

These figures look too generous, given the company's overall repositioning for growth and its track record of achieving that growth. Best of all, its net tangible assets of more than 240 pence per share and respectable stake in the business by the founding Latham family are further reason for confidence.

3. Zetar
The AIM-listed confectionery and snack foods group Zetar (ISE: ZTR.L) specializes in aligning its wares with major brands and character licensing. With shares priced at 197.5 pence, the company's market cap is 26.2 million pounds.

Zetar has grown turnover steadily in recent years, though profits have remained largely flat. Nevertheless, brokers' expectations for this year place the shares on a P/E of just 5.7, which falls to 4.8 next year. There are also net tangible assets of 125 pence per share and net borrowings of 10.8 million pounds. Zetar paid a maiden dividend of 2.25 pence per share last year and has recently been pretty upbeat about its future prospects after a disappointing Easter.

If the company can do this well during the leanest of times, it deserves a higher rating. The shares look solidly defensive and are too cheap for a steadily run, growing business in which the directors have a good stake.

What now?
Of course, there are never any guarantees with individual shares, and selecting companies outside the FTSE 100 generally carries more risk than buying a standard tracker. However, I feel trawling the market, studying annual reports, and assessing valuations can pinpoint potential index-trouncing winners.

Indeed, backing overlooked small caps is one of the "Ten Steps To Making A Million In The Market," a special Motley Fool report that outlines how ambitious investors can start on the path toward a magic 1 million pound portfolio. I'd encourage you to download a copy today. You never know -- the report could transform your approach to investing. The report is free and comes without any further obligation.

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At the time thisarticle was published David owns shares in James Latham and Zetar. He doesn't own shares in Bloomsbury Publishing. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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