Earlier today I wrote at Realmoney:

Good Things Come in Small Packages

8/29/2007 11:49 AM EDT

Every now and then, the market serves up a bargain that is hard to realize, because trading liquidity is poor. I was acquiring this stock for just me, and it took ten days for me to do it. (If at the end of this, you want to buy some, use limit orders. Do not use a market order, and do your own due diligence, please.) National Atlantic Holdings is a small (primarily) personal lines insurer selling almost entirely in New Jersey. No debt. 6.9x 2007 and 2008 earnings, 69% of tangible book. It has relatively defensible boundaries in its lines of business, though no one is totally immune from the dangers of over-competition in the personal lines marketplace. I have met management, and I think that they are competent.

Risks:

Up against larger companies that may be more aggressive in pricing.

Though NJ is good at present for insurance, the legal system has delivered some nasty surprises in the past.

Small insurers are subject to the “Law of Small Numbers,” which means that a small number of untoward events can knock the earnings for a loop.

They have missed earnings more frequently than many investors would like. There are a lot of burned value investors here.

There’s more, but these are the basic points that you can begin with as you do your own due diligence.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider National Atlantic Holdings to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Position: long NAHC

Now for the rest of the story: my average cost is $9.60, and I would not recommend buying above $9.75. There has been some big player liquidating his stake at prices under $10, and I am not sure that he is done. There are significant buyers underneath $9.60, but as with many traders they don’t automatically buy when the sellers arrive there. They let the market sag, and then slowly suck in shares at the bid, while letting the bid back up.

I mentioned the law of small numbers above. Well, that can work two ways. When the small numbers result in few claims in a quarter, the stock can pop, and it gets even better if it happens a few times in a row — then a pattern gets inferred by investors, and often wrongly so, but the price runs then.

There is another risk I did not mention above. They are entering a new state, Texas, and new lines (though not in a big way) in New Jersey. I always worry when insurers do that, because they tend to underestimate the risks involved. That said, NAHC tends to be conservative here, and that ameliorates the risk. That, and the CEO own 13% of the company; he has grown it himself, and doesn’t want to spoil what he has built.

Beyond that, their asset portfolio is clean, in my opinion. Their business in NJ depends on partner agents who primarily market to the wealthy of NJ, and try to cover their full insurance needs through package policies that cover their personal insurance needs, and sometimes their business insurance needs. This allows NAHC to compete away from Progressive and GEICO.

Again, there is more to this story, but please do your own due diligence, and if you do buy, be price-sensitive, and don’t use a market order.

Full disclosure: long NAHC

Tickers mentioned: NAHC, PGR