Our Successful Bet on Companies Analysts Overlook

Last September, I wrote about three “hidden gems,” small companies with impressive businesses and solid growth that analysts just weren’t paying attention to. With one exception, my thesis to invest in these ignored stocks panned out.

A 30% Gain

The biggest winner was Bel Fuse (NSDQ: BELFB), which we sold in November for a 30% gain. In just two months, the number of analysts following the company jumped from two to 11, six of which were “quant shops” and other investment advisory firms. All that new attention coupled with a terrific third-quarter earnings report really made the shares pop.

It’s also a good thing that we sold when we did. Although we left a little upside on the table, we also missed a sharp downturn following the company’s fourth-quarter earnings report. While an improved margin helped push earnings up year-over-year, net sales fell 12.4%. Investors clearly took that as a red flag, and the shares have dropped more than 17% so far this year.

Nice Return but Still Ignored

Simulations Plus (NSDQ: SLP) was another gem, gaining more than 16% over the past six months. As I predicted, its simulation technology continued gaining ground. Whether it’s modeling how a new drug will behave in humans, evaluating the aerodynamics of a car on a highway or determining if a plane will fly, Simulations Plus’s software generates significant cost savings for its clients. The software helps pharmaceutical companies cut the costs associated with enrolling and monitoring human patients in drug trials, and spares car companies the trouble and expense of building a full-size model to evaluate the vehicle’s performance.

Although the technology has been catching on, market analysts still haven’t tuned in. There was only one analyst following Simulations Plus in September, and aside from us, he’s still the only one to do so as of March. Considering the company’s miniscule size—it now has a market cap of $173 million, compared to $160 million six months ago—I’m afraid other analysts will continue overlooking this growing company and its impressive technology. So it’s time to take our gains instead.

Sell Simulations Plus for a 16%+ gain.

The Exception

Of the three ignored stocks, Sapiens International (NSDQ: SPNS) has been our lackluster performer. When I added it to the portfolio six months ago, Sapiens had just four analysts covering it, a number that remains unchanged. That’s not a surprise given how little time has passed, but the election of Donald Trump and the firm Republican control of Congress changed the game a bit.

As a top provider of infrastructure software to the insurance industry, Sapiens’ products help manage policy administration, billing and collections, as well as data mining. Still, regulatory compliance has driven the impressive growth in demand for the firm’s software. Despite a shaky fourth-quarter performance, full-year revenue shot up 20.6%, and operating profits rose 11.6% in 2016. That said, net income attributable to shareholders fell from $20 million in 2015 to $19.3 million last year thanks to tighter margins.

Simply put, Sapiens is in an extremely competitive business that will only become more so. With Trump and Congressional Republicans committed to rolling back regulation, particularly the Dodd-Frank Wall Street Reform and Consumer Protection Act, the regulatory demands driving Sapiens’ business will ease. Dodd-Frank especially adds a layer of regulatory burden on all financial companies, even insurers. Without that added burden, insurance companies won’t be particularly motivated to invest in costly new software products. Added features could help motivate buyers, but providers will be competing mostly on cost, squeezing margins further.

When I recommended Sapiens in September, Hillary Clinton looked like a shoe-in for the Oval Office. If she had won, Dodd-Frank would have been safe and more regulation would have been likely. Trump’s surprise victory upset that calculus, but the shares still rallied—as much as 15% in December and February. At this point, it’s anyone’s guess what happens next. So although we’re down just over 3% on the company, we’re going to sell instead of hold and hope for the best.

Sell Sapiens International.

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