Note from TM editors: This article discusses a microcap and/or penny stock. Such stocks are easily manipulated; please do your own due diligence.

I invest primarily in undervalued small caps and there are always a handful of indicators I explicitly scout for in the selection process. For example, the balance sheet should be clean, meaning no debt and ample cash. Also, the company needs to be in a durable high-growth condition with access to a very large addressable market, so the upside potential is unmistakably there. The insiders need to back up their statements with their own money too, like buying stock in the open market, no selling whatsoever, and owning a sizable portion in their own company. There are a few other factors involved in the process, but it all eventually comes down to a final risk vs. reward assessment. With this strategy, I have significantly outperformed the main indices over the past few years. I think uSell is a classic example of an undervalued and overlooked small cap stock that exactly matches my criteria. This article presents the bull case.

Business overview

uSell is a player in the online expertise called re-commerce. Its online marketplace helps individuals turn unused items, like smartphones and textbooks, into cash. uSell ensures that customers get the highest payouts with the least amount of hassle by facilitating risk-free transactions with professional buyers. uSell doesn’t hold products in inventory, it’s a software-based platform just connects buyers and sellers. uSell generates revenue by charging a commission for each transaction. Here’s a simple step by step of how such a transaction takes place:

This all takes place is a completely hassle free environment. You do not need to upload photos or a description. You also do not need to monitor the auction process or answer messages from potential buyers. uSell will send you a postage-paid shipping kit so you do not have to buy packaging and postage. This is from a customer experience viewpoint clearly preferable over Ebay’s way of dealing with buyers and sellers. That’s not me saying this, but a multitude of review sites. According to resellerratings.com, uSell scores a 9.6 out of 10 based on 1727 reviews, whereas Ebay is awarded an abysmal low 1.25 based on 257 reviews.

What about price? A good customer experience is one thing, but price is another. On average, uSell manages to make sure sellers get a higher price than on Gazelle, another competitor in the re-commerce space. That should not be a surprise, given the fact that uSell does not hold inventory and thus has no inventory related bills to pay. Keep in mind that uSell prices are net prices. Prices on sites like Ebay may appear higher, but if you subtract necessary costs like packaging, the price drops considerably. This angers many customers, which could explain the abundance of negative reviews on Ebay.

On the verge of major expansion

In the few years since its existence, the company has grown from 0 revenue to $6 million annual revenue based on most recent quarters, while they are operating in a highly competitive business. This is impressive, and even though the reported growth so far this year is somewhat lagging due to a recent transition in business model, I think the 50% plunge in share price is way overdone, providing an excellent entry point (think risk vs. reward here). Regarding the business model: Beginning in February 2014 uSell phased in a major change. Under the new model, the upfront lead fees to buyers were eliminated and replaced by fees when buyers actually pay sellers for received devices. This means revenue is recognized only upon actual payment. This is a more transparent and straightforward way of bookkeeping. It also aligns the company’s incentives with sellers and reduces risk for buyers. Management is perfecting a highly scalable revenue platform that ensures uSell will re-enter the rapid growth state by re-investing all cash in marketing and sales. uSell is not reporting a profit right now,but it could switch to profitability any day now. uSell is in fact already generating profit on every transaction, and high margin on every transaction. But the decision to re-invest all cash is a strategic one, similar to what Amazon (AMZN) has pulled off. At first glance, it may come across as a bit illogical to postpone profitability but if this strategy works out, shareholders will be richly rewarded in the longer term.