You may never have heard of this stock, but I recommend that you get familiar with it in a hurry. It is a small cap with a market capitalization less than $500 million, but it has excellent growth prospects. It has a P/E of about 5, no debt, a stellar ROE of 32.4%, a cheap Price/Sales ratio of 0.37, positive cash flow, and a strong growth rate. I also believe it could be an attractive takeover target. Should I continue?
The stock in question is called Xyratex (XRTX). The company is a data storage solutions provider that operates in two segments: Network Storage Solutions and Storage Infrastructure. According to analysts, the company is expanding its relationships with IBM. When I read this I immediately thought that IBM could be a natural suitor for the company given its existing relationships. Hewlett Packard recently won a huge bidding war for 3Par (PAR) which is in the same industry. The acquisition of one small player often leads to consolidation in the industry in order for the bigger players to keep up.
Room to Run
Xyratex has run up from $11 to $15 recently, but I believe it has room to go up much more. The company reports earnings for the August quarter on September 29 and it is likely that the stock will continue its runup into the announcement. Analysts have raised their estimates for the quarter to 94 cents per share, up from 92 cents a week ago and 77 cents 90 days ago. Xyratex has exceeded estimates by an average of 17% over its past two quarters.
Earnings are quite volatile in this sector so a lower than usual valuation is justified for its lack of consistency. However, the stock is trading at a ridiculous 3.9x current-year estimates of $4.01 per share. As I mentioned above, I love the balance sheet with no debt and ample cash. An ROE of 32.4% means that management is extremely efficient at managing shareholder capital.
Given all of the positives I mentioned above, I think the target price of the stock should be significantly above current levels. One should never buy a stock solely because it is a takeover target, but that is a nice pot sweetener in this case. The company is slated to earn about $3 next year. Applying only 10x to those earnings would give us $30 per share, which is almost a double from here. Even if it doesn’t get that high, there is still plenty of upside potential.
Cheap Winner is an article from: 
