In Search of Small Wonders

Portfolio manager Kempton Ingersol makes a case for his favorite small-cap stocks

What’s your forecast for the direction the overall market will take this year?
Well, the significant upside we saw last year, I don’t think we’ll see that strength or magnitude this year. But I do think we could still see measured growth.

What are some companies that fit that mold?
The first company I want to talk about is Neogen (NEOG). They develop a broad line of products focused on food and animal safety. Their products consist of diagnostic test kits for the detection of E. coli, salmonella, food allergens, toxins and any other dangerous, unintended substances, which might end up in the food supply. Their animal safety products include vaccines, vitamins, and various treatments for bacterial and other infections for both animals which will become part of the food supply and for pet animals, including cats, dogs, and horses.
The company also produces rodenticides and disinfectants used in animal and food production facilities.

Neogen’s 2009 revenue was $126 million. The food safety side is approximately 55% of the revenue. The animal safety side is 45%. As food contamination concerns and food recalls continue, that will drive growth for this company. In fact, they recently formed a subsidiary in Brazil, which is one of the world’s largest food exporters, and announced a partnership with the Chinese government to research China’s specific food safety issues. Neogen has consistently grown revenue 15% or more over the last several years. This company is in a very strong position in terms of sophistication of their science and the demand for its products. And at the current revenue level, we think there’s significant room for growth for this company going forward.

Are there other companies with a similar outlook that you’ve identified for your clients?
Quality Systems (QSII). They develop market-leading healthcare information systems, which help to automate medical and dental practices. Companies in the business of medical practice management and electronic medical records software—we believe—are well positioned to benefit from increased healthcare information technology spending, and the effort to reduce medical errors and improve the quality of patient care. It’s no secret that there are big inefficiencies in the medical system. Some doctors’ offices you go into, and they’re still pulling paper files. The company has successfully focused on the small- to mid-sized physician practices and community health centers, a market that is underpenetrated. This company comes in and automates the billing system and the patient information system with different software.

In 2009, Quality Systems increased its sales force and product implementation teams in preparation for increased demand. The company also stands to benefit from stimulus funding and incentives geared toward accelerating the adoption of electronic medical records. Quality Systems has grown revenue over the last five years at a compound annual growth rate in excess of 25%. And earnings have increased at an even higher rate. We expect them to continue to grow revenue and earnings in excess of 20% for the next several years.

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