I want to introduce you to my new newsletter format. I think most of you can handle html format now and I would like to make my newsletter more like a letter. I hope you like the change.

I also want to inform you that I have finished a new set of stock screens. I decided to get creative on these screens and focus on small cap stocks. I also created more than 7 screens so you don’t get bored over the holidays. Click here for the new stock screens:

http://www.rogueinvestor.com/stock_screens

For the feature article, I want to talk about a hidden but great way to value companies.

Feature Article: Market Cap: A simple but very effective way to determine if a company is a bargain.

When everyone is talking about P/E ratios, cash flow, return on equity and the other bazillion stock valuation measures, sometimes you need to step back and get simple. How about just looking at the total value of the company, also called Market Capitalization or Market Cap, and deciding if the total value of the company is cheap or over-priced?

Benjamin Graham was a strong proponent of this theory. If you could buy the whole company, would you buy it for the current price? After all, what are you doing when you buy stock in a company? You are buying part ownership in the company. If you would not buy the entire company for the asking price, why would you buy a portion of the company?

Using the market cap as a valuation measure is also a great way to measure companies that have no current earnings or are going through some weird business cycles. For example, many biotech companies have no earnings but they may have a promising drug in the pipeline that could make the company very valuable someday. By looking at market cap, you can get an idea if the company is undervalued compared to what the drug could be worth in the future. Also, when a company makes an acquisition or sells a part of the business, it can be a good rule of thumb to look at how the market cap changes in the first six months to a year after a major business change.

I also use market cap as another test. The larger the market cap of a company, the harder it is for the company to grow their earnings at a high rate. For example, Microsoft has a current market cap of over 250 billions dollars. How many copies of Windows do you think Microsoft has to sell to even budge such a large market cap?

Contrast this with Daktronics (DAKT), a company that makes scoreboards and large video displays. The current market cap for Daktronics is about 450 million dollars. A few large orders from college teams for new scoreboards and Daktronics can grow their sales and raise their market cap easily.

I am not saying never invest in large companies. However, when you invest in large companies realize that it is much harder for these companies to raise their market cap and increase your investment in the company than it is for smaller companies. Never ignore market cap when you are looking at the value of companies and you will have a good, easy stock valuation tool that few others use.

Stock of the Month: Compudyne (CDCY)

Speaking of small companies, the stock of the month is another security-related firm, Compudyne (CDCY). I profiled this company some time ago, but they are starting to get a head of steam and I think the company could do very well over the next year. CDCY builds blast-proof structures for embassies and other government buildings, retrofits prison facilities, and provides specialized security software for airports, in addition to manufacturing other miscellaneous security products.

Using my market cap valuation technique, CDCY’s total current market cap is about 70 million dollars and the company has already booked new sales just over the last few months of more than 30 million dollars. This means the company may be able to grow their sales and earnings at a 40 to 50 percent clip over the next year. Also, the government is letting many new security contracts, including fortifying embassies across the world – and this is one of CDCY’s specialties. Debt is acceptable at less than 50 percent of market cap and the company’s P/E ratio of about 25 is reasonable compared to a possible growth rate in earnings and sales of greater than 30 percent. Insiders also own about 30 percent of the company, so they have a strong vested interest in the success of the company.

Since this company is small and therefore contains more investing risk, I would not recommend putting anything but your risk capital in this stock; but it could double or triple in value over the next year if it stays on track.

Overall, Compudyne is a stock worth looking into.

Company info:
http://moneycentral.msn.com/investor/research/profile.asp?Symbol=US%3aCDCY

Recent news and contract awards:
http://news.moneycentral.msn.com/ticker/rcnews.asp?Symbol=US%3aCDCY

Happy holidays,

Bryan Rundell