My Top 5 Small-Cap Stocks to Own Right Now

It’s crucial to avoid the trap of focusing on the same types of investments for your portfolio. Investors tend to focus on large caps, small caps or dividend-paying stocks exclusively, when they should own a basket of all of them. A diversified portfolio still brings the best combination of risk and reward, as you’re not beholden to a specific economic or financial trend. For example, investors who own nothing buy high-yield stocks may underperform the market if interest rates start to rise and government-sponsored yields become comparatively more appealing.

So even as I tend to mostly focus on large and stable companies, I also keep an eye on small-cap stocks and low-priced stocks. These kinds of stocks are either off the radar or out of favor, and often appreciate smartly while few investors even notice.

Here are five stocks under $5 that hold appeal right now. Each carries more risk than a large and stable blue chip, so it’s wise to make smaller investments in them. By doing so, you can add some upside to an otherwise steady-as-she-goes portfolio.

1. Hecla Mining (NYSE: HL)
This silver miner trades just above its 52-week low, thanks to a series of recent stumbles, including the late 2011 closure of its Lucky Friday mine. It will be several quarters before this mine is back in operation, so analysts have had to sharply curtail their forecasts for 2012 output and profits.

But Hecla also has a range of other mines ramping up, so the stage is set for a much better 2013 and 2014. Per-share profits, for example, are expected to rise from about $0.30 to $0.50 in 2013. Equally important, the company’s mines are quite valuable: Merrill Lynch says they’re worth a collective $5.80 a share in terms of Net Asset Value (NAV). That’s roughly 50% above the current share price. And this assumption is based on a long-term price assumption of $27 an ounce for silver. The current spot price is around $30.

2. Wendy’s (NYSE: WEN)
This past week marks the one-year anniversary for Emil Brolcik, the new CEO of this fast-food chain. During the past year, the proven industry veteran has taken a close look at operations and ultimately unveiled a turnaround strategy, which I wrote about here.

The market remains dubious, as shares are exactly where they were a year ago. But as I cautioned back in January, turnarounds can take several years to play out. On a purely qualitative basis, Brolick’s vision for Wendy’s makes ample sense. Focus on quality ingredients, and you can separate from the fast-food pack. Whether Brolick can execute on his plan is still an open question, but the earnings leverage in this business model makes this stock a potentially strong gainer during the next few years.

3. Gafisa (NYSE: GFA)
I wrote about this Brazilian homebuilder roughly a month ago and it still appears to offer high risk and high-reward. Simply put, the Brazilian housing sector is currently retrenching after a building boom that led to a housing glut. The excesses are being worn off, and with the Brazilian economy expected to get a major boost from the World Cup and the Olympics in coming years, the housing market should spin back to life in a year or so. Meanwhile, a drop from $18 to $4 in the past 18 months has pushed this out-of-favor stock into value territory. Shares now trade not far above book value of $3.31 a share. And this figure has been heavily marked down from write-offs that likely undervalue Gafisa’s real estate holdings when the Brazilian economy turns back up.

4. Celsion (Nasdaq: CLSN)
This is the only biotech stock I’m focusing on right now. Celsion has developed ThermoDox, which is a heat-activated drug delivery technology currently in Phase III testing for liver cancer. As with many biotechs, the company must keep reloading the balance sheet with more cash to stay afloat, which has heavily pressured shares. The good news: Investors need not wait years and instead just a few more quarters to analyze that Phase III data. If the news is good, then Celsion is likely to pop up on the radar of many biotech investors. In a best-case scenario, ThermoDox could be selling in Europe and China in the first half of 2013, and in the United States in the second half of the year. Management will provide a progress report when first-quarter results are released in mid-May.

5. Cenveo (NYSE: CVO)
Buying on the way down. That’s what insiders have been doing at this printing company. The still-slow economy, coupled with a move toward electronic communication has led to a pullback in demand for printed envelopes, stationary, labels and direct mail materials. Sales of $1.9 billion in 2011 remain below the $2.1 billion peak seen back in 2008. But even with top-line challenges, Cenveo still throws off ample free cash flow: $65 million in 2011 and a cumulative $350 million during the past five years.

Yet shares remain under pressure because Cenveo carries more than $1 billion in debt. As a result, the company generated $133 million in operating income in 2011 but had to pay out $116 million of that in interest payments. So here’s the opportunity for investors: Pay close attention to operating income and interest expense when first-quarter results are released in a few weeks, (and perhaps again in the June quarter). If operating income is starting to pull away from interest expense, then Cenveo may have the makings of a solid turnaround candidate.

Risks to Consider: In a falling market, investors tend to especially shun small-cap stocks, so these companies could fall even further out of favor if the indexes pull back sharply.

Action to Take –> These companies aren’t simply cheap. They’ve stumbled badly (except for Celsion, which had a too-weak balance sheet). But in each case, a clear path to upside exists. Quarterly results will tell us if they are getting back on the right path. If results are positive, then you might want to take a modest amount of cash in your portfolio and put it into one or more of these stocks.

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