Dr. Gerald W. Perritt, the founder of Chicago-based portfolio manager Perritt Capital Management, wrote a whitepaper a few years ago entitled “The MicroCap Advantage.” As the title suggests, it discussed why investing in undervalued micro-cap stocks makes sense.

The whitepaper showed that between 1926 and 2018, the compound annual growth rate (CAGR) of small company stocks was 11.8%, 180 basis points higher than the return for large company stocks. Further, despite the risk, small company stocks outperformed large company stocks in 54 of the 89 years.

The only caveat?

The annual standard deviation of small company stocks was almost two-thirds greater than their large company counterparts. Therefore, investing in micro-cap stocks is best if you have a fully-diversified portfolio that allocates a significant weighting to large-cap stocks.

With that in mind, I’ve selected seven undervalued micro-cap stocks from the First Trust Dow Jones Select MicroCap Index Fund (NYSEARCA:FDM), a collection of 201 small company stocks.

The exchange-traded fund (ETF) is down 11.15% year-to-date through Aug. 9. To qualify, a stock must be down by more than that amount.

Undervalued Micro-Cap Stocks: Entravision Communications (EVC)

Entravision Communications (NYSE:EVC) is a Los Angeles-based operator of an advertising, media, and technology solutions company.

It owns the largest digital advertising company in Latin America. It also operates digital marketing businesses in Asia and Africa. In 2012, Entravision generated 2% of its overall revenue from digital advertising. It now accounts for 73% of the company’s sales.

In addition to digital, it owns 49 local television stations in the U.S., catering to the Hispanic market. It is Univision’s largest affiliate group. Its stations have 3.7 million weekly viewers. It also operates 46 radio stations in 16 markets, reaching 96% of the Latino population.

Between 2019 and 2021, it grew its revenue by 67%, compounded annually to $760.2 million. On the bottom line, it increased its adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) by 46% to $88.0 million.

Based on its 2021 free cash flow of $59.43 million, it has an FCF yield of 15.1%. I consider anything above 8% to be in value territory.

Lovesac Company (LOVE)

Lovesac Company (NASDAQ:LOVE) has lost almost half its value in 2022. Despite the significant decline, its shares are still up 114% from its June 2018 initial public offering.

Lovesac’s best known for its modular couches, known as Sactionals, as well as for its Sacs, foam beanbag chairs. In the first fiscal quarter of 2023, its revenues jumped 56.0% to $129.4 million, while its adjusted EBITDA increased 19.5% over last year. It finished the first quarter with 162 furniture showrooms, 46 more than Q1 2022.

“Since our IPO four years ago, trailing 12-month sales have quintupled. We’ve driven trailing 12 months EBITDA from being negative into the double digits,” Lovesac CEO Shawn Nelson said about the company’s growth in its June conference call.

For the trailing 12 months (or TTM) ended Q1 2023, Lovesac’s FCF per share was $1.01, the highest since 2017. While its FCF yield of 2.9% isn’t in value territory, its growth more than makes up for the high valuation.

Interestingly, during its conference call, the company said its sales per square foot were almost as high as Apple (NASDAQ:AAPL) and Tiffany, owned by one of my favorite companies, LVMH (OTCMKTS:LVMUY).

2023 appears to be Lovesac’s year.

Undervalued Micro-Cap Stocks: Central Garden & Pet (CENT)

I’ve always thought that Central Garden & Pet (NASDAQ:CENT) has never quite lived up to its full potential, although its annualized total return over the past decade was 15.99%, 263 basis points higher than the entire U.S. market.

Between gardening and pets, you’ve got two of the most significant areas of consumer spending. Yet, it always seems to hit periods of underperformance. Take its latest quarter, for example. Its net sales decreased 2% — they were down 5% organically — while its operating income was up by 1%, but only because of a 12% increase from its Pet segment.

In fiscal 2017, it had revenue of $2.05 billion. In 2021, they were $3.3 billion, 61% higher. Its operating income over the same period increased 63% to $254.5 million, from $156.1 million in 2017.

The big positive: If you only look at the last three years, you will likely have a different impression of the company.

Valued at 0.73x sales, it hasn’t traded at this low a multiple since 2019. I wouldn’t bet the farm on CENT, but a small wager at current prices should pay dividends in 18-24 months.

Oppenheimer Holdings (OPY)

Next on my list of undervalued micro-cap stocks is Oppenheimer Holdings (NYSE:OPY). Oppenheimer is a middle-market investment bank and full-service broker-dealer based in New York.

The company’s stock is down more than 19% YTD due to a significant reduction in investment banking fees. In late July, it reported second-quarter 2022 results that included an 83.6% decline in advisory fees to $8.28 million from $50.5 million in Q2 2021. Oppenheimer’s revenue in the quarter fell 30.3% to $237.2 million, with a loss of $3.9 million.

On the plus side, its tangible book value per share increased 16.8% in the second quarter to $53.62 from $45.90 a year earlier. That’s due to share repurchases. YTD Oppebheimer has bought back 1.26 million of its shares. That’s a 10% reduction in its share count in the first half of 2022.

In a business like investment banking, the fact that CEO Albert Lowenthal owns almost 27% of the equity and controls 97.5% of the votes is a good thing, in my opinion, because it doesn’t hide who’s boss.

The investment banking business will return, and when it does, OPY will rebound.

Undervalued Micro-Cap Stocks: Cross Country Healthcare (CCRN)

If you run a company with any medical staffing needs, Cross Country Healthcare (NASDAQ:CCRN) is one of this country’s leading human resources specialists, with more than $2 billion in annual revenue. 

Founded in 1986 and publicly traded as of 2001, Cross Country’s 36-year journey has taken it from small business to digitally-savvy healthcare recruiter and staffing expert. The money spent on healthcare staffing across the country has more than doubled since 2013, from $10.2 billion to an estimated $24.7 billion in 2021. 

That’s good news for Cross Country’s shareholders. And it’s likely to get even better as management continues to scale the business, making it more efficient and profitable. 

In Q2 2022, the company increased its revenues by 127% to $753.6 million, while its adjusted earnings per share increased 198% to $1.40. Nurse and Allied Staffing led growth, up 131% in the quarter. 

Down almost 20% YTD, it’s currently valued at 0.33x revenue. It hasn’t been valued this low since 2018. 

If you believe the healthcare staffing shortage will continue indefinitely, CCRN is a stock for you to consider seriously.

Interface (TILE)

Interface (NASDAQ:TILE) started in 1973 when founder Ray Anderson saw a carpet tile in Europe and thought it would go over well in the U.S. 49 years later, Interface generated $1.2 billion in annual revenue from more than 100 countries.

Anderson, who passed away in 2011 from cancer, was an industry leader in sustainability. He set out in 1994 to get the company to zero waste, zero impact, and zero environmental footprint by 2020. As a result of Anderson’s Mission Zero project, Interface has significantly reduced its global environmental footprint.

While initially intended for the office market, Interface now generates 52% of its revenue from non-office purposes. It is the market share leader in the $5 billion carpet tile industry.

It’s also working hard to become the global leader in both luxury vinyl tile (LVT) and rubber flooring markets. Its total addressable market has more than doubled over the past couple of years to more than $9.0 billion.

Its current earnings yield is 8.53%, higher than in the past decade. That makes it an easy buy.

Undervalued Micro-Cap Stocks: RMR Group (RMR)

RMR Group (NASDAQ:RMR) is a Boston-based alternative asset manager specializing in commercial real estate. It has more than $37 billion in assets under management (AUM).

The real estate investment trusts and assets it manages own more than 2,100 properties across the country. The company’s holdings are diversified amongst several types of commercial real estate, including retail, office, senior living, industrial, and hotels.

In February, I included RMR in an article about stocks to buy paying special dividends in 2021. It paid out $7 in special dividends and $1.52 in regular dividends in 2021. It currently yields 5.64% without any special dividends. That’s more than decent.

As I said in February, the company continues to grow its private capital AUM, which leads to higher fees. In the third fiscal quarter of 2022, the company earned $2.94 million in fees from its managed private real estate capital clients. That was up 130% from Q3 2021, so the plan appears to be working.

RMR Group’s forward price-to-earnings ratio is 12.66, the lowest since 2017. As recently as 2018, its share price traded close to $100.

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.