4 capital gain favorites for the second half

by Richard Moroney, editor Upside Stocks

Shares of many high-quality small and midsize companies are trading at attractive valuations, and our Quadrix rating system continues to do a good job of isolating winners. You can build a relatively diversified portfolio of smaller stocks without settling for second-tier names.

We see appealing stocks in several groups likely to outperform over the next six to 12 months. Here's four favorites for capital gains the second half of the year: AmTrust Financial Services (AFSI),  Bio-Reference Laboratories (BRLI), Dillard’s (DDS) and Dolby Laboratories (DLB).

Amtrust FInancial has surged 22% so far in 2012 but still has plenty of upside. The specialty insurer is benefiting from favorable pricing, strong client retention, and prudent risk management.

The company focuses on insurance for workers compensation and extended product warranty coverage. Recent results reflect higher fee income and improved underwriting results.  

AmTrust stands tall on two important operating metrics. On March 31, per-share book value was $15.91, up 24% from a year earlier. Over the last three years, book value has grown at a 32% annualized rate.

Return on equity was 19% in the March quarter, versus an average of 7.5% for the 57 property and casualty insurers in Quadrix. AmTrust, capable of increasing 15% to 20% in the next 12 months, is a Best Buy.

Bio-Reference Labs has rallied 28% over the past month, fueled by a combination of strong April-quarter results and takeover speculation.

A leading provider of medical testing services, Bio-Reference earned $0.33 per share, up 27% and a penny above the consensus. Revenue advanced 19%, partly reflecting a 16% increase in patients served.

News that rival Medtox agreed to be acquired by Laboratory Corp. of America for a nearly 40% premium helped propel shares of Bio-Reference higher.  

Increased contributions from high-end medical tests and market-share gains should help sustain growth. For fiscal 2012 ending October, per-share earnings are expected to reach $1.46, up 26% on an 18% sales increase.

For fiscal 2013, per-share profits are expected to climb 19% on a 16% sales gain. Trading at 20 times trailing earnings -- a 20% discount to its 10-year average P/E -- Bio-Reference is a Best Buy.

With more than 300 department stores and clearance centers in 29 states, Dillard’s has a strong and growing market position. In recent years the retailer has im- proved same-store sales, inventory turnover, and revenue per square foot.

Dillard’s Overall Quadrix score of 99 ranks among the top 1% of U.S.-traded stocks and places it No. 1 among the nine department-store stocks in our research universe. Dillard’s earns a 75 or higher in five of the six Quadrix categories.

The company has delivered three straight positive profit surprises, surpassing the consensus by an average of 26%. At less than 14 times trailing earnings, Dillard’s trades at a 25% discount to its five-year average. Dillard’s is being upgraded to Best Buy.

Dolby Laboratories fortunes are entwined with consumer electronics, including tablet computers and smartphones, that play digital content.

The company’s technologies help maintain sound quality while enabling content to fit within the stor- age capacity of a device. Many movie, television, music, and video game studios produce content encoded with Dolby technologies.

The company recently unveiled a new audio system for theaters, with Disney-Pixar’s Brave the first feature film mixed for the new platform. Microsoft will use Dolby’s audio technology when it launches the Windows 8 operating system later this year.

Dolby earns an Overall score of 92, with strong scores for Quality (93) and Financial Strength (95). Shares seem unduly cheap at 14 times trailing earnings, especially considering the balance sheet has more than $10 per share in cash. The stock is a Best Buy.

Learn more about this financial newsletter at Richard Moroney's Upside Stocks.

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