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 seem to be a bad time to back the market through an exchange-traded fund such as the HSBC FTSE 100. Standing at 5,664, the blue-chip index currently trades at a price-to-earnings ratio of 10.3 -- a multiple well below the average of 15 seen since the start of 2000.

That said, there are always shares that look like 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. St Ives (ISE: SIV.L)
These are tough times to be a printer, and St Ives group is the U.K.'s biggest. When the market was still feeling optimistic about the world in the autumn of 2007, St Ives' share price was above 290 pence. That didn't last, though, and the shares' slide has never really been reversed. With a current share price of 71 pence, the company's market capitalization is 81.45 million pounds.

During that five years, St Ives' performance has been patchy but not as bad as the share price would have us believe. The company has recently reinvented itself somewhat through acquisitions, and it now provides "joined up marketing across a range of physical, digital and social media."

Its marketing businesses offer some potential for growth, while print margins remain under pressure.

But this isn't a growth story for me as a potential investment. Instead, I'd consider it for the maintenance of the prospective dividend. The brokers expect the dividend to be 5.5 pence, rising to 6.3 pence next year -- a whopping 8.9%. This looks doable, as the yield is well covered by earnings. The expectations for the current year place the shares on a P/E of 4.8 for this year, falling to 4.3 next year.

The balance sheet looks reasonable with net debt of 9.6 million pounds -- despite the investment of 10.5 million pounds in recent acquisitions -- and net tangible asset value of more than 32 million pounds. St Ives also expects to complete the sale of its property in Crayford for 3.3 million pounds soon, while there are three other surplus properties for sale with a combined value of around 4 million pounds.

2: Trinity Mirror (ISE: TNI.L)
Trinity Mirror has to be just about the cheapest company on the market on prospective and historical P/E and price-to-cash-flow.

At a share price of 28 pence, the market cap is 72.15 million pounds, and brokers' expectations for the current year place the shares on a P/E of 1.2. (In case you're wondering, the decimal point is in the right place!) And this is the aggregate forecast of five brokers, with a high degree of consensus.

The market seems to be making a snap judgment that there's no great future in the newspaper business. Trinity publishes five national newspapers, more than 130 regionals, and 500-plus digital products for advertising and such.

One of the best-known Foolish investors agrees on the basic cheapness of the shares. The problem, of course, is debt. Net debt of 221 million pounds makes the P/E more like 4.9 against enterprise value. But Trinity did manage to reduce its debt last year by almost 45 million pounds with strong cash flow. At this rate, the company could be debt-free in four or five years, allowing it to resume dividends. Also, the group's freehold property currently valued at 177 million pounds may be worth more in practice.

Again, this is no asset play. But if you believe Trinity's earnings can be maintained at anything like the current level, then the shares are inexplicably cheap.

3. ZincOx Resources (ISE: ZOX.L)
The flipside of the above two situations, where the market seems to be overly discounting what it sees as declining businesses, is ZincOx Resources, which has unrecognized growth potential. With a share price of 66 pence, the company has a market cap of 58 million pounds.

The company takes waste product from the steel industry free of charge; puts it through its Korean recycling plant, which yields a high quality zinc concentrate; and then sells back the balance of material as a low-grade iron bearing product.

It's rare to find a jam-tomorrow stock on a lowly P/E rating -- and to be fair, ZincOx only makes it on consensus prospective earnings for 2013 of 7.14 pence, which places the shares on a P/E of 9.2.

Nevertheless, I think this will come to pass, as the company is doing everything right so far. But as a shareholder, I'm more optimistic about what its earnings will be five years from now. ZincOx says its first plant (which cost $110 million) is working well and is in ramp-up mode. It plans another Korean plant of the same size, and its operations are backed by 10-year supply agreements with the Korea Zinc company, covering approximately 400,000 tons per annum.

Meanwhile, the company has 12 million pounds in cash following a fundraising in December to help fund its second plant in South Korea and to enable the technology to be rolled out in the U.S., Turkey, and Thailand as ZincOx aims to become the world's largest recycler of zinc. If all goes according to plan and the price of zinc holds up, the shares will be a lot more expensive in a year or two than they are today.

What now?
Of course, there are never any guarantees with individual shares and trackers. However, I feel that trawling the market, studying annual reports, and assessing valuations can pinpoint potential index-trouncing winners.

Indeed, backing overlooked small caps is one of the ideas featured in "10 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, your approach to investing could be transformed. The report is free and comes without any further obligation.

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At the time thisarticle was published David owns shares in ZincOx Resources. He doesn't own shares in St. Ives or Trinity Mirror. 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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