Three Small-Caps Loved by Value Pros

• BySham Gad, RealMoney Contributor
• On 4:02 pm EDT, Tuesday August 25, 2009

While the stock market rally has propelled just about every asset class higher, the performance of smaller-cap companies has been astonishing. According to one measure by Jeremy Grantham at GMO, since the rally took hold, stocks trading under $5 on average have risen by over 100%.

Despite this enormous reversal, there still remain some small-cap names that have lagged. Interestingly, I've discovered some small-caps that haven't participated in the rally but which continue to be owned by some the best value investors on the planet. And since the true value investor is wired to protect the downside first, these names could spell opportunity today.

If the market is indeed headed for a pullback, these laggards could be more resistant to future price declines. And if the market continues to go up, it may finally be time for them to shine.

Two years ago, TravelCenters of America was trading for over $35 a share. Today, this owner and operator of highway travel centers trades for less than $3. Whenever you are traveling on a highway and come across one of those huge gas stations that often include a Burger King, Wendy's or other fast-food names, that's what TravelCenters does. In their most recent quarterly filing, Ian Cumming and Joe Steinberg at Leucadia disclosed a new position in TravelCenters.

To be sure, TravelCenters' operations are characterized by thin margins. The key to the business is volume, mainly the volume of truck miles driven. Clearly, with the recession in full swing, the volume of trucks that carry inventories has come down.

TravelCenters was spun off from Hospitality Properties Trust a couple of years ago, and financial arrangements remain in effect between the two in terms of lease payments and such. Hospitality Properties has every incentive to keep TravelCenters going and is currently allowing it greater flexibility with its financial payments. TA has tremendous upside if it can manage through this recession.

On the commodities side, International Coal Group is a $500 million coal producer put together by none other than Wilbur Ross. Ross is known for buying distressed assets cheap and turning them around for a tidy profit. He did this when he was buying steel mills when they were being given away, and he made a killing handing them over to U.S. Steel.

ICO is a collection of coal mines bought out of bankruptcy. Despite the anti-environmental effects of coal, it continues to remain the most efficient and inexpensive way to provide electricity. Plus, the U.S. has tons of it, and any hope of weaning the country off of foreign oil -- a bipartisan effort -- includes coal. Prem Watsa at Fairfax Financial owns 23.7% of ICO.

Probably the most contrarian name of the three is RHI Entertainment. It currently trades at $2.50 a share, and the market cap is an ultra-small $33 million. However, Seth Klarman's multi-billion-dollar hedge fund finds enough value to own nearly 37% of the company. Despite its small size, RHI trades fairly heavily, offering investors an average volume of 100,000 shares a day. On a couple measures of value, the stock looks cheap: a price-to-sales ratio of 0.18 and a price-to-book ratio of 0.40.

RHI is a developer of television programming worldwide. The company holds rights to a deep and valuable library of media content that it licenses to popular cable networks. It has a 48% market share of the mini-series category and an overall share of 22% of the mini-series and "made for TV" movie market. Media giant Disney comes a distant second with 10%. Despite the half billion in debt on the balance sheet, RHI owns an incredibly valuable library of assets.

Generally, investors have done quite well buying stocks that were being left for dead. You buy them when nobody else wants them and get paid when the mood turns. Of course, there's no guarantee that assures capital gains. But when you have some smart money in for the ride, you get one potential value-creating catalyst.

To be sure, the above three investments represent a small portion of each value investor's portfolio. Nonetheless, guys like Klarman, Watsa and the folks at Leucadia don't invest a dime unless they see value.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider TA and RHIE to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Buzz up!