5 Small-Cap Stocks On The Brink Of Being Great Bargains

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For investors who check the daily finish of the S&P 500, it would appear as if the stock market is the picture of health.

That index of large companies stands within 1% of its all-time high. But for the stocks of smaller companies, the seas have grown steadily rougher.

The Russell 2000, a small-cap index, is off roughly 5% in the past month and has now seen several rapid pullbacks since the start of the year. This index has seen solid buying support at the 1,100 mark (it currently stands at 1,140) in prior dips, but if the recent pullback pushes the Russell below the 1,100 threshold, investors may conclude that the bull market for small caps is over and it's time to focus elsewhere.

To be sure, small caps have been in rally mode ever since the bull market began in March 2009.

Back then, the Russell 2000 stood below 400. Such stocks always rally coming out of recessions, but as I noted last yea r, they tend to lag the market in the latter stages of a bull market. We may now be witnessing a grand rotation out of small caps, and if so, you can read about solid some solid mega-cap exchange-traded fund ( ETF ) choices in this column .

The main reason to be cautious about small caps is that they can lose value quickly, even when the major indices drop just 1% or so. In fact, in the recent choppy market environment, of all stocks with market values between $50 million and $2 billion, 285 have lost at least 15% of their value over the past month.

In past market dips, it's been wise to snatch up these laggards, as they have tended to rebound in equally vigorous fashion. (Indeed, the notion of "dip-buying" was recently noted by Bloomberg News .)

Yet you shouldn't ignore history. When small caps begin to wobble, they can signal broader market uncertainty as investors start to make a flight to quality.

All that said, small-cap investing can be especially profitable, as these companies are more likely to be ignored by the crowd and you can get an edge by researching them closely.

Moreover, the recent pullback in many small-cap stocks has left them clearly in bargain territory. As a result, this is a time to be focusing on which small-cap stocks to buy -- after this period of choppiness ends.

Here's a quick list of small-cap stocks that I track that have fallen a fair bit from their highs and would likely be bid back up once investors grow comfortable with small caps again.

• Accelerate Diagnostics (Nasdaq: AXDX ) : This company, which is developing tests to rapidly detect infectious diseases, has lost a third of its value in just six weeks, though it has recently seen a considerable level of insider buying support.

• Rally Software (Nasdaq: RALY ): This enterprise software firm has seen its shares fall from $30 last fall to $20 this past spring to a recent $10. Yet as I noted a few weeks ago , one Wall Street analyst sees a rebound to $25.

• Bon-Ton Stores (Nasdaq: BONT ): This department store has seen weak traffic at its stores, which pushed shares down from $19 a year ago to the $11 range this spring. The recent small-cap breakdown has pushed shares to just $9.

• Tile Shop Holdings (NYSE: TTS ): In tandem with fellow flooring firm Lumber Liquidators (NYSE: LL ) , this stock has utterly cratered in the face of tepid second-quarter results. The still-weak housing market appears to get some of the blame, but a long-term expansion plan is likely to attract growth investors again in coming quarters.

• Varonis Systems (Nasdaq: VRNS ): Just five months ago, this provider of data analytics pulled off a successful IPO, and shares quickly moved above $50. Shares now trade near $20 as investors quibble with the company's move to aggressively hike R&D spending. Varonis reports quarterly results on Aug. 4, giving investors a timely view into business conditions.

Risks to Consider: In the context of the past five years, the Russell 2000 is a lot closer to its all-time high than its low. As a result, the current bout of profit-taking and general skittishness towards small caps may continue for quite some time.

Action to Take --> These aren't stocks to buy -- at least not yet. Instead, this is a great time to research the issues behind their sharp drops. Once small-cap stocks stabilize, these oversold stocks (on a technical basis) may deliver rapid upside once investors go from risk-off to risk-on.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Investing Ideas , Stocks

Referenced Stocks: ETF

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