This Small-Cap Shows That Size Matters
By Jody Chudley | May 04, 2018 |

Let me shed some light on where the greatest stock market returns are generated.

Over the last 90 years, the market’s smallest stocks with market caps averaging just $114 million have been the best performers with an incredible 17.45% annualized rate of return.

Compare this to the market’s largest stocks, with an average market cap of $88 billion, that have returned just 9.21% annually.

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The reason for this outperformance is simple…

Institutional investors cannot fish in this pond. The companies are too small for them to invest any meaningful amount of cash and therefore bargain opportunities are able to exist.

This is where the market is inefficient.

The data is screaming to us that small-cap companies are an ideal place to find great equity investments. So let’s do exactly that.

Growth At A Bargain Price — Ashford Inc. (AINC)
Ashford Inc. (AINC) provides asset management services to two NYSE listed real estate investment trusts, Ashford Hospitality Trust (AHT) and Ashford Hospitality Prime (AHP).

With a market capitalization that has been hovering around $200 million, this is just the kind of under-the-radar business that outperforms over the long-term.

The first REIT, Ashford Hospitality Trust, invests in full-service and upper-upscale hotels in diversified markets. In total it has 120 hotels and 25,000 plus rooms. The second REIT, Ashford Hospitality Prime, focuses on luxury hotels and resorts covering 12 hotels and 3,600 rooms.

Combined, these two REITs operate 132 hotels and have $7.5 billion on total gross assets that Ashford Inc. is in charge of managing.

As the asset manager, Ashford Inc. gets paid a management fee from the two REITs. That fee is based on the $7.5 billion in gross assets that these REITs have. As the REITs grow their assets, so too grows the management fee that Ashford Inc. collects.

Historically that growth has been excellent.

I’m talking about a compounded annual growth rate of over 25% since 2003. Yes, that rate includes the financial crisis and is something that I expect to continue.

But there is more to the story…

As the manager of all of these hotels, Ashford Inc. effectively controls how those hotels spend billions of dollars every year.

Not surprisingly then, Ashford Inc. has invested in a few businesses that provide services to hotels. For example, Ashford Inc. purchased J&S Audio Visual which is a company that provides audio visual services for hotel conventions, conferences and business meetings.

I know of at least 132 hotels that are going to be customers of J&S Audio…

Similarly, Ashford Inc. made an investment in a company called Pure Rooms, which is in the business of making hotel rooms hypoallergenic for $30 per night.

You can bet there will be additional opportunities to capitalize on servicing hotels down the road.  This will add more growth to the management fee growth that has been compounding at more than 25 percent per year for 15 years.

Great Balance Sheet + Incentivized Insiders At An Attractive Valuation
In addition to having a rapidly growing asset management business and opportunities to cross-sell services, Ashford has three other very attractive features.

The first is the balance sheet. As of the end of December 2017, Ashford was in a strong financial position with the company sitting on $40 million of cash while having zero debt.

The second is that insiders are highly incentivized to build shareholder wealth.

I’m a huge believer in the power of proper incentivization and Ashford’s insiders own three times more shares than the average of its peer group.

The third is an attractive valuation. Ashford Inc. trades for 8 times EBITDA (earnings before interest taxes depreciation and amortization). Meanwhile, the most comparable publicly traded competitor, RMR Group (RMR), trades at 15 times EBITDA — almost twice the valuation!

Not surprisingly, RMR’s market capitalization is almost ten times that of Ashford and institutional investors have been attracted to the RMR story. As Ashford continues to grow, I expect that institutional investors will move in here as well and Ashford’s valuation multiple will increase.

For now this is a high quality small company available at a discounted price.

This article originally appeared on The Daily Reckoning.