In recent weeks, I've been focusing all my efforts on large- and
stocks, especially those with strong balance sheets and consistent
free cash flow
. Many of these rock-solid companies offer a degree of stability in
this choppy market and are currently trading at outstandingly cheap
values. In effect, they allow you to play offense while being
On the flip side, small- and micro-cap stocks are far less
resilient. As investors continue their "
flight to quality
," these stocks are being deeply shunned. Until we have a clear
sense of the potentialduration and depth of a possible
loomingrecession , investors will keep selling off smaller company
But there's a curious twist to this oft-repeated cycle. When the
finally arrives (which is still not a given), small stocks tend to
actually outperform. We're now cycling through the 20-year
anniversary of just such a move, and you need to watch for signs of
Back in 1990, the U.S.
was quickly losing steam when
gross domestic product (
growth fell from a robust 4.2% in the first quarter to -3.5% in the
fourth quarter. This should have spooked small-cap investors.
Instead, they started to buying aggressively, anticipating the
eventual economic rebound.
Russell 2000 Index
of small-cap stocks bottomed out at the end of the third quarter of
1990 at 119, but it would hit 144 by year-end (even though the
economy slumped badly that quarter), and would hit 178 by the
following May. That's a 50% gain in just seven months, even though
the economic data painted a bleak picture. (The
went up to about 200 by the end of 1991, even though
growth didn't prove to be robust until the first quarter of 1992.)
The key takeaway: small caps represent great buying opportunities,
even when the economy looks scary, so it pays to keep a watch list
prepared. Here are three small-cap stocks that could double or even
triple in value when the Russell 2000 finally rebounds. It may take
a few years for this to fully play out, but the upward move may
come sooner than you think.
1. Power One (Nasdaq:
This is a solid company stuck in a tough industry. Power One makes
a range of power conversion and power-management components. The
company has had notable recent success with inverters that help
solar panels and wind turbines convert their variable power
generation into energy flow that is suitable to feed into
electricity grids. This has proved to be a choppy business, because
the renewable fuels industry has seen major peaks and valleys.
Still, Power One is taking
from rivals, maintaining sales levels while rivals see sharp drops.
Power One is likely to post flat sales this year of $1 billion.
Earnings per share (
are expected to fall about 20% to around $0.90 this year. Growth is
likely to resume in 2012 at a moderate double-digit pace as stalled
power projects finally come to fruition. Meanwhile,shares trade for
just five times trailingearnings . As business moves back up onto a
growth trajectory, look for the multiple to move up into the low
teens, implying at least a double for this beaten-down name.
2. Exide Technologies (Nasdaq:
In keeping with the energy/power theme, this auto battery maker has
been too sharply discounted. (
I recently suggested
Exide could be part of a paired trade strategy.) The company had
seen profits slump as lead prices surged. Lead is Exide's biggest
raw material expense.
The company belatedly pushed through price increases for its
batteries, which should help profits rebound. As a further
tailwind, lead prices are finally in retreat. They peaked above
$1.30 a pound in the spring, and are now $1.05. As those factors
finally hit the
, look for much better quarterly results. In a stable pricing
environment, Exide's annual
could hit $200 million, which is more than half of the stock's
. Simply applying a multiple of five on normalized operating income
would make this stock triple.
3. KIT Digital (Nasdaq:
This is a very promising -- and hugely frustrating -- company. KIT
has built an impressive suite of products to help companies develop
sophisticated video services on a wide range of platforms. Thanks
spree, the company now has a broad set of tools to offer, which is
fueling 100% sales growth this year and projected 40% sales growth
(to $300 million) in 2012. To pay for these deals, the company has
raised fresh capital several times. The number of
keeps rising -- from 7 million in 2009 to a recent 33 million --
take a big hit every time another capital raise is announced.
Management is expected to finally stop issuing fresh equity, which
should enable investors to focus on the attractive core business.
Recent major contract wins with John Malone's Liberty Global and
Korea's LG should help KIT to post very solid growth metrics in
coming quarters. This sub-$10 stock could move north of $20 when
quarterly results are more robust and investors finally can trust
that no more capital raises will be needed. A $20 target price
implies a target 2012
before interest, debt,
) multiple of just 10, which is quite reasonable for a high-growth
stock like this.
Risks to Consider:
Small caps like these will only find traction with investors
once they prove their ability to boost profits, regardless of
expectations about the broader economy.
Action to Take-->
My friend Andy Obermueller, editor of
, often says investors should allocate about 20% of their portfolio
to more speculative high-growth stocks. While not the game-changers
Andy typically looks for, these three stocks certainly fit the
high-growth bill. All of them were in the teens earlier this year,
but I expect them to return to previous peaks once the near-term
gloom abates. Although they appear to have solid upside during the
next 12 months, each also looks well-poised for continued strong
growth in their respective industries, which could help them rise
even higher beyond 2012 as well.
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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