From employment trends to factory production levels to trade
figures, all signs are pointing to an improving U.S.economy . And
in the early stages of any economic rebound, investors always flock
to stocks with small market capitalizations. Back in 1990, when the
was about to break out of its shell, the
Russell 2000 Index
, which focuses on small cap stocks, rose 100% during the next 36
These days, these small caps are back in vogue again. The Russell
2000 has risen for seven of the last eight months. Theindex is now
within just a few points of all-time highs hit back in 2007.
Unlike blue chip stocks found in the S&P 500, smaller
company stocks in the Russell 2000 tend to be much more volatile.
Of course, that means even bigger gains in rising markets for some
names. Right now, I'm taking a closer look at the hottest small
caps, those Russell 2000 components that rose more than 50% in
March. These sharp moves may be a harbinger of even better days
ahead, or they may have become over-inflated in a euphoric market.
Let's take a look...
Drugstore.com (Nasdaq: DSCM)
moved higher on a
posted remarkably good fourth-quarter results and could see even
higher demand for its hydraulic and electronic equipment in 2011,
butshares are no longer a bargain. And
Vasco Data (Nasdaq: VDSI)
may be up on rumors of a coming
or it may be perceived as a beneficiary of a recent security flaw
found with rival
products. Let's call these stocks fair-valued.
A star in the making?
I have to admit that I was wary of
Star Scientific (Nasdaq: CIGX)
, when I
noted last summer
that the company had a history of false promises.
It now looks as if management may finally deliver on years of
hopes. The Food and Drug Administration has just issued a ruling
that Star's tobacco lozenges won't be regulated like other tobacco
products. That bolsters the company's claims that its tobacco
products aren't nearly as carcinogenic as traditional tobacco
What does this mean for investors? Well, for starters, revenue may
finally start to roll in after being stuck below $1 million for
each of the past five years. How high can sales go? Expectations
should be tempered. Major tobacco companies such as
R.J. Reynolds (
Phillip Morris (
are testing their own dissolvable tobacco products. And with their
marketing muscle, Star may be hard-pressed to compete.
I'm more intrigued by the company's claim that one of the key
ingredients in the tobacco product could also have therapeutic
abilities, such as the ability to possibly cure Alzheimer's
Disease. Right about now, you should stop and realize that
companies have been coming across "cures" for Alzheimer's for a
long time, yet not a single one has actually ever proven effective
in large-scale testing. So these claims should be taken with a
mighty large grain of salt. That said, this stock pounds out gains
day after day, and some of its most bullish backers think
have room to run much higher, so it's certainly worth further
research. But you should also know that this stock surged in 2000,
2005 and 2009 to $5 only to give back those gains every time. Will
this time be different?
Travelzoo (Nasdaq; TZOO)
Here's the recipe for a high-flying stock. Find a company that is
being targeted by short-sellers, and then get that company's CEO on
TV with stock entertainer Jim Cramer and watch the shorts run for
the hills as mom-and-pop investors follow instructions to "Buy,
buy, buy." The shorts were right in early March when the stock was
at $40. Forced to cover those positions, they've pushed the stock
right up to $68. Now this stock is really, really
, at nine times trailing revenue, 24 timesbook value and 50 times
trailingfree cash flow .
Travelzoo toils in the crowded field of online travel, which is
dominated by firms like
Priceline.com (Nasdaq: PCLN)
Expedia.com (Nasdaq: EXPE)
. With $113 million in 2010 sales, Travelzoo is the smallest of the
For quite a while, itsbusiness model held a lot of promise. The
company quickly built a list of 22 million subscribers who received
"travel deal" e-mail blasts. That approach is now showing signs of
fatigue. The company boosted the subscriber base by just 1%
sequentially in the fourth quarter.
Looking ahead, the company is trying to ride the coattails of the
new group-buying frenzy pioneered by sites such as groupon.com and
livingsocial.com. Truth is, those firms are securing far more
traffic than Travelzoo. Travelzoo will capture some of the buzz and
a bit ofmarket share , but its main core business has so greatly
slowed that the company may be hard-pressed to boost sales 20% this
year, as analysts currently forecast. In short, this is a company
that is a lot better at generating investor buzz than actually
building sales. The shorts had to cover their positions back when
the stock was at $40, but at $70, this is a screeching short.
The one to own
The only stock in this group that has my attention is
VirnetX Holdings (VHC)
I discussed last summer
The stock has tripled since then and may have even more room to
VirnetX holds a number of key data-transmission patents and has
started to pile up legal victories. Last August, the company's IP
strategy was still evolving and some expected major patent
infringement lawsuits had yet to be filed. I concluded that "it's
impossible to predict if and when those suits will be resolved, but
VirNetX's $270 millionmarket value appears to sharply discount the
prospect of a few more major legal victories."
is now almost $1 billion, yet it appears that annual royalty
payments could be even higher than I first thought -- well into the
hundreds of millions. In mid-March, the company updated its patent
protection plans and now looks to be positioned to secure royalties
on all smartphones that transmit at high speeds, known as "4G."
Over their lifetime, those royalty streams could total several
billion dollars. So the company's market value, even after a strong
run, still discounts potential coming windfalls.
Action to Take -->
Of this whole group, TravelZoo looks full of hot air, while VirnetX
Holdings seems to have even more upside -- perhaps 50% or more from
-- David Sterman
P.S. -- Few investors realize that a 20-year energy agreement
between the United States and Russia is about to expire. This deal
supplies 10% of America's electricity. As broke as our government
is, the situation is so serious that President Obama is asking for
$36 billion to avert this crisis. And Republicans support him.
Here's what's going on…
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.