Synopsis: In this article, I will define Orphan Stocks, how to identify one, the unique opportunity, provide a real example, and tease a recent orphan stock buy from our research.
We primarily research and recommend sustainable, resilient growth businesses for the growth element of client portfolios. Great long-term capital compounding stocks that serve to form the growth “foundation” of a well-constructed portfolio. During our research, which includes analyzing over 6,000 growth stocks each year, we also identify other stocks that appear miss-priced. These anomalies may offer potential opportunities for our clients.
One of these groups we call “orphaned stocks”. Let’s take a quick look at why we see select value in this unique subset and how they can produce significant returns for investors with the ability to take on above-average risk in a growth-oriented portfolio.
What is an orphan stock?
Most often, orphan stocks are small capitalization (under $1 billion in market cap, typically closer to micro-caps with market caps of less than $150 million), that have been ignored by the investment community. As a result, they trade at low valuations measured against their current or future prospects.
There are many orphaned stocks on the market, most for good reason – they are terrible or unproven businesses. A couple of times a year, we come across potential “orphan stock opportunities”. Anomalies we estimated to be 50 to 100% plus undervalued. We consider these companies on the higher end of our risk scale within our coverage universe and require a minimum of 50% undervalued relative to their intrinsic value to compensate for the well-above-average risk. If properly identified, an orphan stock opportunity has significant upside potential and can be well worth the consideration for risk-tolerant investors as part of a well-constructed 20-25 stock portfolio.
True Orphan Stock Opportunities are extremely rare.
We estimate that we find about 2-5 potential names annually after researching 5,000+ stocks. In theory, the markets are all about efficiency, so a stock trading at 50% of its intrinsic value is a definite anomaly – it makes sense that you will not come across such opportunities every day. True Orphan Stock Opportunities have the potential to provide an element of higher risk growth that can be lacking in the average Canadian and U.S. stock portfolios.
Why does a stock become orphaned?
There are a few reasons a stock can become orphaned, but chief among them is a lack of value creation from a shareholder perspective.
The late legendary investor Charlie Munger is fond of the basic idea that, over the long term, fundamentals are like gravity. If a stock you own creates consistent per-share cash flow, often free cash flow per share growth, the stock price tends to stick to it like glue and rise over time. This is shareholder value creation 101.
Conversely, if the business of a stock you own does not create shareholder value long-term, committing several of KeyStone’s “Stock Sins”, including:
- producing no or limited revenue,
- limited to no historic profits,
- weak margins,
- limited or negative growth per share,
- constant share dilution,
- or poor business structures.
These “stock sins” create a business that is the antithesis of what we look for in a great long-term stock.
If a stock displays some of these symptoms long-term, it can become orphaned or ignored by the market.
What changes a floundering business into an “orphan opportunity”?
Most often, for an orphaned stock that has been on life support for years to become a potential opportunity, we need to see a fundamental change in the business that dramatically alters the company’s profitability equation.
A catalyst that brings about change through a spike in per-share profitability, which is what ultimately drives stock prices.
How do we identify these orphan stock opportunities?
There is no magic button or simple formula to help you discover these market anomalies. Your best weapon is brute force and volume. We come across 2 to 5 of these orphan opportunities annually, from looking at thousands of companies.
The research is time-consuming but can be very rewarding and does not involve conventional screeners. We put a team of actual analysts to work and review the disclosures, conference calls, presentations, and financial statements of thousands of public companies to identify these anomalies, before the broader market. When a potential anomaly (orphan stock with a catalyst) is identified, we conduct investigative interviews with management.
We exploit the inefficiencies at the less-followed end of the market.
The Process to find Orphan Stocks.
Once we identify a potential orphaned opportunity, we often wait until the catalyst takes hold to confirm our thesis. Awaiting the release of at least one set of quarterly financial results before we step up and buy.
This confirmation helps allay some of the execution risk and helps prevent becoming stuck in an investment “concept” that continues to suffer from failure to launch. While one might think the release of a strong quarter would immediately become priced into the stock, in most cases, an orphaned stock, by definition, is underfollowed and therefore, the initial stages of the catalyst opportunity are acted on by no investor of consequence. The derisking gained from the confirmation most often outweighs a slightly higher entry price and the downside of moving too early and becoming stuck in an illiquid stock that does not deliver on the catalyst.
Once confirmed, we act swiftly. We are ready with a buy recommendation including a buy range, rationale, and a potential time frame.
Proof of Concept: NTG Clarity (NCI:TSX-V)
For “proof of concept” about Orphaned Stock Opportunities, I present NTG Clarity (NCI:TSX-V), a digital transformation business that provides telecommunications engineering, information technology, networking, and related software solutions to clients in the enterprise, telecom, utilities, financial, IT, and government sectors. Ninety-five percent of the company’s revenues come from Saudi Arabia, with no current exposure to tariffs.
The orphaned small-cap was recommended to KeyStone clients in July 2024 at $0.78. After identifying the company as a potential orphan stock opportunity, we interviewed management and recommended the stock as a SPEC BUY with a significant catalyst in place.
Why was NTG Clarity orphaned?
For the 9 years between 2014 to 2022, NTG Clarity failed to produce anything close to consistent growth. 2014 revenues were $15.5 million, and by 2022, the company had grown revenues marginally to $17.7 million, with a low $7.9 million in 2020. Profitability and margins were weak, with more years producing a net loss than income. The profile was not that of a company that should attract investor attention. The stock was orphaned, suffering from low volumes and, rightfully so, a lack of investor interest.
Fast forward two years, and a catalyst appeared to have taken hold. Powered by a promised $1.3 trillion in investment in technology by the Kingdom of Saudi Arabia in a massive digital transformation, NTG Clarity had posted significant growth, backed by a low-cost, viable labour force in Egypt, introduced strong growth guidance for 2024, all backed by a record backlog.
We received confirmation in the form of the company’s breakthrough $0.06 in EPS delivered in the company’s Q1 2024, up from under a cent in Q1 2023. The company’s revenue growth combined to produce higher margins and higher EPS. We had part of our confirmation.
Let’s rewind to the fundamental value and growth equation that led us to believe that NTG Clarity was an Orphan Stock Opportunity.
In July 2024, the stock traded at $0.78.
Based on management’s guidance, our initial earnings estimate was ~$0.13.
Based on this, the Forward PE was ~6.
Our initial fair value (based on a low multiple of 10x our 2025 initial estimate of $0.13) was $1.30, a 68% potential return, falling well within our return requirement for a higher-risk orphan stock opportunity.
Shortly after, we issued a BUY report at $0.78.
In the less than 10 months since, the stock has posted 3 more record quarters and has jumped 169% to the $2.14 range.
In a recent client update, we significantly increased fair value based on our FY 2025 estimates and a record backlog of around $105 million. NTG Clarity serves as an excellent example of the strong potential gains one can achieve by strategically investing in this unique category of small-cap stocks.
What is KeyStone’s next Orphan Stock?
I like to conclude with a current example.
KeyStone recently released a new orphaned stock buy report on a profitable, lesser-known gold and mineral service small-cap stock that traded under $1.00. This stock has just reported breakthrough earnings, benefits from booming gold prices in uncertain times, and is trading at an 80% discount to our fair value.
The stock has gained over 50% in the last couple of months but remains 40% below our fair value. Canadian Small Cap and VIP clients currently have access to the research on this stock.
