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The Clear Advantage of Micro-Caps

Companies such as Liberator Medical hold potential that big names just can't match.
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If I were to sum up why I enjoy searching for ideas among small-caps and micro-caps, it's this: You get to play with weighted dice. You get to invest at inefficient prices, much in the same the way that ultra-large investors get to participate in buyouts, securities offerings and takeovers. 

As much as they would love to, investors such as Warren Buffett, Seth Klarman, Mason Hawkins, David Einhorn, Bruce Berkowitz and all the others who work with billions of dollars can't spend a single minute looking at businesses that have market caps of less than $1 billion. They have put money in mega-cap names like IBM (IBM), Apple (AAPL) and Chesapeake Energy (CHK). Buffett himself has even stated that if he were starting over with a much smaller sum, he would be focusing on smaller issues. 

Which brings me to a neat little company, Liberator Medical Holdings (LBMH), a direct-to-consumer distributor of medical supplies for the elderly in the U.S. Its products include catheters, diabetic supplies and other high-volume products demanded by today's aging population. 

Liberator turned profitable in 2009, and since then, the company has been off to the races. After earning $2.2 million in 2009, Liberator has been profitable ever since, and for the first six months of 2013, net income came in at $2.7 million. Gross margins came in at nearly 60%, and the company has no debt and is spinning off tons of cash. 

Liberator has a market cap of $76 million and trades for $1.48 a share, up from $0.56 a year ago. The run-up has been huge, but so is the company's potential. Net of cash, the enterprise value is $68 million, and the company generated $3.7 million in free cash flow for the first six months of 2013. 

At a current price-to-earnings ratio of 18 and an enterprise-value-to-EBITDA ratio of 9, Liberator hardly seems to be a value stock by purist standards. And clearly the run-up indicates that more people have become aware of the company. Even so, this is a very attractive business that has exceptional margins and is capable of producing growth, and that makes it cheap today. This year, the company started paying dividends of $0.03 per quarter, equivalent to an 8% yield today. 

These types of numbers, if they existed in a large-cap security, would probably produce valuation multiples a lot higher than what Liberator is currently getting. To be sure, Liberator is a tiny company and is susceptible to greater shocks than bigger, more established businesses. Still, all great companies start somewhere. 

At the time of publication, Gad was long LBMH.