4 Surging Small Caps That Could Go Higher

We’re now in a “stock picker’s market.” The major averages are now moving sideways after a sustained two-month upward move, which means that stock selection becomes ever more crucial.

In this kind of trading environment, it pays to see what’s working. Insights into why certain stocks are sharply rising while most stocks stay in a range can help sharpen your understanding of investor psychology and sector catalysts. [Read our free course: “Catalyst Investing Secrets”]

With that in mind, here’s a look at four small cap stocks (members of the Russell 2000 Index) that have risen at least +50% in the past month.

iStar Financial (NYSE: SFI)
When you’re carrying more than $8 billion in debt, it’s crucial that your cash flow stays strong to cover principal and interest payments. So when iStar, a major lender to commercial real estate developers, noted this summer that more than 40% of its clients had stopped making payments, short sellers started to smell trouble. By September, iStar conceded that it may need to seek bankruptcy protection. That’s like manna from heaven for short sellers. But they’d soon be disappointed: iStar announced in late October that it was able to raise cash by selling some major loans it held, and that in turn would keep its own lenders at bay for a while longer.

The course is still tricky. A June 2012 bond was recently paid off, but iStar still needs to come up with roughly $3 billion more to pay off debts in 2011. Alternatively, the company could seek to extend the expiration of its 2011 obligations, a task that is now much easier in light of a somewhat stronger balance sheet. That move appears increasingly likely, so the bankruptcy risk should go away. But is the stock undervalued after the recent rebound? Yes — with caveats.

iStar’s real estate loans were worth more than $11 billion a few years ago, but the company has had to write off roughly $5 billion of that amount. If the commercial real estate sector starts to rebound (a real possibility if employment picks up and companies need more office space), then much of those write-downs could be written back up. iStar’s equity is now worth just $500 million, and a $2 billion to $3 billion write-up in the next few years could push the company’s equity value back up to $1 billion or even $2 billion (iStar’s equity was worth $4.5 billion before the economy tanked). Any fruitful discussions about loan extensions could push shares up +50% toward $8, and a materially stronger economy could push this stock to $15 or $20.

Broadsoft (Nasdaq: BSFT)
Start with a fairly unknown company, toss in a fairly limited trading float, and then sprinkle in an impressive quarter. Those ingredients are the recipe for a very strong stock surge for Broadsoft, which helps standardize data streams across a range of hardware platforms. The company is now on track to boost sales +30% this year, and at least another +20% next year, as major network operators are currently investing in data flow improvements.

Trouble is, this stock is now in the hands of momentum investors who have pushed up shares for six straight sessions for a tidy gain of about +66%. Daily trading volume has surged, but as soon as it cools, momentum investors are likely to book profits, especially since shares now trade for more than 30 times upwardly-revised 2011 profit forecasts. If you like Broadsoft’s business model, you need to wait for a pullback.

Motricity (Nasdaq: MOTR)
When I looked at this wireless software vendor company back in August when shares traded for less than $8, I thought they looked undervalued. Now with shares approaching $30, they clearly look overvalued. And we have stock cheerleader Jim Cramer to thank for that. He’s been talking up the stock recently, even though it now trades for more nearly seven times projected 2011 sales and more than 30 times next year’s profits. Needham’s Mark May, who has been a booster of the stock since its June, 2010 IPO, thinks it’s worth only $23 — roughly -20% below current levels.

Cheniere Energy (AMEX: LNG)
Back in 2006 and 2007, this company was a key member of many energy-focused portfolios. Cheniere was building specialized energy terminals that could receive and house imported liquefied natural gas (LNG) in the Gulf of Mexico to help the United States address a looming shortage of natural gas. But by 2008, dozens of untapped new gas fields were found, creating a sudden glut and removing the need for natural gas imports. Shares subsequently lost -90% of their value.

Yet Cheniere is turning lemons into lemonade by repositioning its energy depots to export LNG. The move makes sense. The U.S. is now the world’s largest producer of natural gas, exceeding output in places such as Russia, Iran and Australia. And the price of natural gas in Asia is 150% higher than here in the U.S.

Cheniere initially planned to build three LNG terminals but was stopped in its tracks after the first one was built. Those stalled second and third plants may get the green light — if the company can secure a range of long-term supply agreements. China has already signed on, and other Asian nations may follow suit. Despite the recent pop, this could quickly become an even hotter stock if new contract agreements are announced.

Action to Take –> Both iStar and Cheniere are high-risk/high-reward plays that could merit a small speculative position. It would be nice to see a pullback (which should be a rule of thumb with any hot momentum plays), but a clear case can be made for significant further upside. Motricity and Broadsoft surged last month for justifiable reasons, but they’ve gone too far, too fast.