This Stock is an Undiscovered Canadian Real Estate Gem

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In looking for a small cap to add to my portfolio, I have found that many American firms already appear to be near full value. However, when investigating Canada, I noticed Melcor Developments (TSX: MRD) which despite a housing sector recovery, hasn't shot up in price as high as many of its Canadian counterparts. Everything about the firm screams "buy," and I may do just that in the next couple days.

Company books are stellar

Melcor has managed to increase annual revenue by an average of 26% in each of the last three years. Its profit margins are even more impressive -- annual profits averaged 30% during that period.

But why does this firm still only have a P/E ratio of 5.5 when the industry average is 20.1 (according to RBC Direct Investing)? It appears that investors have missed the profitability of this stock, and that could be because the firm has flown under the radar due to low sales compared to its counterparts. Sales were CAD $275 million last year, which is not a lot in the industry, and investors still cautious from the recession are likely putting their money with the larger businesses. 

I don't agree with those fears, and see the company's heavy exposure to Western Canada (particularly Alberta), as a potential money pump. Alberta is the nation's oil sector hub, and is soaring above the Canadian average in family income. The median family income in the province was CAD $85,000 per year in 2010 -- while the average Canadian family made under CAD $70,000 per year -- says the most recent Statistics Canada census report. That helps spur on a booming housing sector in the province, as well as potential profits at Melcor.

Larger real estate firms are safer

With a market cap of CAD $1.4 billion, and last year's sales at CAD $416 million, Morguard (TSX: MRC) hasn't flown under the radar, and is likely near full valuation. According to Morningstar, the firm's fair value is CAD $115.18, and it is currently trading at around CAD $107. However, the company looks to be expanding. On June 21, the firm announced its acquisition of five hotels in the Toronto area for over $70 million.

Morguard's trading volume is about 4 times that of Melcor, and this indicates the stock in not undiscovered by most. When I look for small cap investments, I want a company that is flying under the radar. As its exposure increases (and if it is a healthy company) the price will often skyrocket. 

Dundee (TSX: DC.A) is worth about CAD $1.1 billion and has a daily dollar trading volume of about $2.2 million, making this a discovered stock and not likely to surprise anyone with a substantial share price increase. However, according to BCMI Research analyst Chris Damas, the company has stalled in price. He made that claim in April during an interview with the Financial Post. Since that time, the company has risen a bit, but continues to trade in the low $20-range. 

The firm has managed to increase revenue by about 75% in the last four years, but hiccups lead me to want to avoid the stock. For example, while revenue increased by CAD $281 million from 2009-10, it fell by CAD $107 million the year after. I always look for steady increases in revenue over the last 5 years before purchasing a stock -- and that's another reason why Melcor shines over the competition.

Canadian housing sector

The short-term outcomes of the Canadian housing sector looks to be dim, according to ScotiabankHowever, prices in Calgary and Saskatchewan look to increase, an analyst with the bank said recently. Those communities are areas where Melcor is heavily invested, and could continue profits despite the nation's overall anticipated downward trend. 

Phillip Woolgar might buy shares of Melcor Developments in the next 48 hours. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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