News Analysis date published New: 
Wednesday, September 26, 2012 - 09:00

2 Small-Caps With Huge Potential Signaling 'Buys'

The biggest winners in the past several decades have included "boring" companies like soda and energy drink maker Monster Beverage (Nasdaq: MNST), an 83,000% gainer, and UGG boot maker Deckers Outdoor (Nasdaq: DECK), which gained more than 10,000%. Studying these and other big winners, we can identify some simple characteristics that the greatest stocks share.

First and foremost is that the biggest winners are all real businesses. Small-cap stocks can include companies that are developing products or services, but have not yet generated any sales. As MNST and DECK demonstrate, there is no need to buy before sales confirm that the company has a viable business opportunity. A record of sales is what distinguishes low-priced stocks with potential from the thousands of penny stocks that will never amount to anything.

In addition to sales, the biggest winners also all started their quadruple-digit run-ups from a small market cap (less than $350 million) and a low stock price (less than $10 a share, and occasionally less than $1).

We want to buy when they have positive momentum because that indicates that there are other buyers looking at the stock. One mistake many value investors make is buying stocks that have good fundamentals but that other investors aren't interested in. This is the "value trap" where a stock with low valuation remains undiscovered for years, and it is easily avoided when momentum indicators are added to the screening process.

One stock that fits this profile right now is CryoLife (NYSE: CRY). This company has a market cap of about $160 million and has reported sales of at least $100 million a year since 2008. CRY has recorded income from operations in each of the past six years.

Its fundamentals look strong with a price-to-earnings (P/E) ratio of about 18 based on next year's estimated earnings and a dividend yield of 1.7%. Occasionally small companies will pay a dividend to make the stock more attractive to institutional investors and that may be a factor that CRY considered. Company management does seem to believe their stock is undervalued because they have initiated a buyback program, something that is usually done only when management feels the stock is trading at a bargain price.

CRY is expected to report earnings growth of about 32% next year, making it a growth company in an industry with strong growth potential. The company preserves and distributes human tissues for transplantation and develops implantable biological devices for cardiac and vascular uses. And CRY trades at about half the industry price-to-book (P/B) value offeringupside from a fundamental perspective.

Technically, CRY is a strong stock with potential to deliver large gains. The monthly chart is shown below and the weekly chart shows that relative strength (RS) is rising and thestochastics indicator is bullish, among other buy signals.

CRY could deliver a 25% gain in the next 12 months if it hits our initial target of $7.42, and additional gains are possible after that. Support at $5.20 can be used as a stop.

Another small company with big potential is Journal Communications (NYSE: JRN). This is a diversified media company that owns 33 radio stations, 13 television stations and publishes a number of newspapers. It could benefit from political advertising this year, and with television stations in several important battleground states, an upside earnings surprise seems possible. JRN has beaten analyst forecasts twice in the past four quarters and matched expectations in the other two quarters.

The chart shows that there is significant potential in this stock. The monthly chart is shown below to highlight the triangle pattern that has formed during the past year and a half.

Like CRY, the weekly chart is also bullish with a rising RS line and a bullish stochastic signal among the reasons to buy this stock. A move to $8.17 for a 47% gain in the next year is possible, and the risk can be managed with a stop-loss at $5.36, which is only about 3.4% below the recent price.

Small companies can deliver big gains. These two stocks offer solid fundamentals and strong technical patterns. Small companies also have the greatest potential risk in the market, but CRY and JRN offer relatively low risk, an important consideration when selecting small-cap stocks to trade.

Action to Take --> Buy CRY at the market price. Set stop-loss at $5.20. Set initial price target at $7.42 for a potential 25% gain in the next 12 months.

Buy JRN at the market price. Set stop-loss at $5.36. Set initial price target at $8.17 for a potential 47% gain in the next 12 months.

This article originally appeared on TradingAuthority.com:
2 Small-Caps With Huge Potential Signaling 'Buys'

Michael J. Carr does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.