At the beginning of 2013 Equities.com began tracking a group of small-cap stocks called the Small-Cap Stars. Utilizing a series of sector-specific criteria, the research team identified 524 plays that qualified for inclusion.
The stocks included had to meet at least one out of five criteria specific to their sector. Out of the 542, there were a handful that only hit one benchmark, or two, but all five. Today we’re taking a look at the only small-cap play in the Healthcare sector that did so: Rochester Medical (ROCM) .
Background on Rochester Medical (ROCM)
Headquartered just south of Rochester, MN in the city of Stewartville, Rochester Medical manufactured and designed catheters. Founded in 1988, the company went public in 1991. Two years later the company launched its first Rochester brand products, and topped sales of $1 million.
Since then the company grew slowly yet steadily to be eventually valued at $247.19 million. In September, the company agreed to be acquired by CR Bard Inc. (CBR) for $20 a share, a 45 percent premium on their prior valuation.
The day's subsequent gap meant that by year’s close, Rochester had risen over 75 percent in value.
As Rochester was acquired during its tracking, it might not seem to be worth looking at closely. However, a look into what made Rochester such a strong healthcare play can explain why it received such a high valuation in its buyout.
Here is the criteria Equities.com uses for evaluating small-cap healthcare stocks:
EV/EBITDA: The inclusion of EBITDA as opposed to EBIT or EBT shows that measures of interest expense, taxes, and dep/amort are all important to healthcare companies. Healthcare is an industry that places a premium on high valuations, so it makes sense that the companies with higher initial valuations would perform better.
Value/Book Value of Capital: The relationship here for healthcare companies is establishing what the book value is compared to the market value. As opposed to financials, for healthcare this works as a valuation metric of its balance sheet assets compared to its market value. A higher ratio implies higher valuation which we’ve established to be good.
FCFF (Negative): Free cash flow to the firm is the amount of cash left over after all expenses are covered. A high metric is good for many industries, but for healthcare, which is an industry that requires constant innovation, it is considered to be a sign that the company is not adequately investing, proof of this is shown in our next category.
Capital Expenditures: Higher capital expenditures means that company is spending more to develop and grow its business, in the healthcare industry this is extremely important.
Intangible Assets/Total Assets: This is perhaps the least surprising metric for healthcare. Healthcare is an industry that is dependent on its patents, which are included in intangible assets, so a higher ratio would indicate that the company has a strong future.
Rochester met four out of five of the criteria, only falling short in the Value/Book Value category. Bard no doubt was aware of the company’s strong fundamentals when they snatched up Rochester. For out of every small-cap on the market, they truly stood out.