What to Buy: Exchange Income Corp (TSX: EIF, OTC: EIFZF)

Why to Buy Now: Exchange Income Corp is a small Canadian buyout firm that specializes in the aviation and specialty manufacturing sectors. Similar in philosophy to Warren Buffett, management has assembled its portfolio of 11 companies by looking for the right company in the right market at the right price with the right management team. And it’s willing to walk away from a deal that doesn’t meet its stringent criteria.

The stock hit an all-time high of CAD28.84 in March 2013, but currently trades near CAD22.70, or down about 21.3 percent. The stock fell as low as CAD17.99 in early October, when the company reported an unexpected CAD10 million rise in expenses at one of its subsidiaries. But management believes this will be a one-time item. The shares have since risen about 26.2 percent from that level, and yield 7.4 percent at current prices.

More important, the stock has strong analyst sentiment, with six “buys,” three “holds,” and one “sell.” After a somewhat dismal 2013, analysts forecast that adjusted earnings per share will jump 181 percent in 2014, to CAD1.44 from CAD0.51, on an 11 percent rise in revenue, to CAD1.14 billion from CAD1.03 billion. The consensus 12-month target price is CAD25.46, suggesting a potential return of 12.5 percent above the current share price.

In the short term, however, analysts forecast that earnings per share will continue to decline during fourth-quarter 2013, for which the company has yet to report, and first-quarter 2014. The rebound in earnings doesn’t get fully underway until the second half of the year. So if expectations regarding near-term earnings aren’t already reflected in the share price, then there could be additional downward volatility over the next few months, unless the company’s numbers surprise to the upside.

But the shares have demonstrated considerable upward momentum since their 52-week low, so it’s possible that the worst is over as far as the selloff goes. And over the long term, the company’s stock has rewarded investors handsomely as it’s grown via acquisition, gaining 20.3 percent annually in US dollar terms over the 10-year period from the end of 2003 through the end of 2013. Including the reinvestment of dividends, the stock gained 33 percent annually over that same period.

While the stock may not produce such stratospheric gains in the future now that it’s on the cusp of moving up to being a small-cap stock from a micro-cap stock, we believe the CAD470 million company is still capable of producing enviable long-term gains.

Buy EIF below USD22. Please note that this is technically a micro-cap stock, with relatively low trading volume–the average daily trading volume over the trailing three months for the TSX-listed shares was roughly 46,000. Over that same period, the average daily trading volume for the OTC-listed shares was just 755. As such, investors should opt for the TSX-listed shares, if possible.

Regardless, low volume means shares on either exchange may trade at wider bid/ask spreads than larger-cap fare. The share price could also spike if there’s a sudden influx of market orders. Therefore, investors should always employ limit orders set near or slightly below the market price to purchase shares, or near or just above the market price to sell shares.