How Big Gains Come From Small-Cap Stocks

The first thing I noticed about Bill Dreher was his size.

He’s a big, imposing character. Think rugby front rower, or Aussie rules ruckman.

We’d chatted on the phone, so I knew Bill’s personality was larger than life…but I wasn’t expecting such a hulking unit when I strolled into his 16th floor office on Wall Street.

I probably should have known. Everything’s bigger in America. The meals, the cars…and apparently, the stockbroking analysts.

I’d flown from London to New York to pick Bill’s brain on retail stocks. Here’s the most important lesson I took home. Size matters…just not in the way you might think.

I marvelled at the trinkets in Bill’s office — a talking Donald Trump figurine took pride of place — and admired his view of Lower Manhattan’s skyline. After that, we got down to business.

I asked Bill for his best idea — the highest-potential US-listed stock that I could recommend to my fund manager clients back in London, where I was living at the time.

‘That’s simple,’ Bill told me. The stock he pointed out was Dillard’s, Inc [NYSE:DDS].

This might be the first time you’ve heard about Dillard’s. It’s a retail department store chain headquartered in Little Rock, Arkansas. Dillard’s operates just over 300 locations across 29 US states.

Most Dillard’s stores are located in suburban shopping malls in the southeast, southwest and midwest regions of the US. In other words, off the beaten path for Wall Street analysts.

That explains why Bill was one of only two analysts in New York who followed Dillard’s.

A company of that size would be a household name here in Australia. But Stateside, Dillard’s is just another small-cap stock.

Or at least, it was back when Bill tipped me off to it.

You see, this was in the aftermath of the great financial panic of 2008. Dillard’s was a hated player in an unloved sector.

That’s why the market had beaten down Dillard’s shares to within an inch of their life. The shares fell from a peak of US$40.56 to a low of just US$2.50 in only 18 months.

As Bill put it to me then, ‘it’s been a crazy environment…once we decided a company wasn’t going bankrupt, we upgraded our recommendation to buy.’

That’s what made Dillard’s such a great opportunity. Investors had sold down its market cap to a relatively tiny US$200 million. The market was pricing Dillard’s as if it was going out of business.

That was amazingly cheap for a company that had earned US$246 million of net profit just three years earlier, and US$69 million the previous year — and even more so for one that owned almost all of the land under its stores.

You might spot a parallel there with one stock that is soon to leave the ASX, David Jones Ltd [ASX:DJS].

But the similarities end there. A corporate raider would have a hard time taking over Dillard’s like Woolworth’s Holdings Ltd [JSE:WHL] is buying out David Jones.

As Bill explained, ‘Dillard’s can’t be taken out because the shares have a dual-class structure. That lets the founding family control the board.’

That structure made it hard for outside investors to shake up the company. It also kept would-be hedge fund predators at bay.

In the four years since Bill tipped me off to Dillard’s, the company has gone from strength to strength. Dillard’s has cut costs and boosted sales. Its profit margins have soared and the stock has rocketed.

Read the rest of this article at Money Morning