Inside the Numbers: Small-Cap Stocks Poised to Pop

Fact: The S&P 500 is up more than +68% since the lows of March 2009. In light of this bit of information, it might be tempting for investors to become discouraged. After all, how much farther can the market rise?

But looking at the past will only get you so far. What we’re looking for are tomorrow’s winners. And if we only stick with the “big dogs” on Wall Street, then we’ll miss out on one of the market’s most potentially lucrative spaces.

I’m talking, of course, about small-capitalization stocks.

In general, the market-cap range for small-cap stocks is considered to be between $150 million and $2 billion. It’s easy to understand why some might be leery about these stocks — a small, upstart company doesn’t get the same amount of press that, say, Apple (Nasdaq: AAPL) or Wal-Mart (NYSE: WMT) does. Fewer analysts follow small caps, and share prices can also be more volatile than larger stocks — but that isn’t always a bad thing.

Don’t forget, Apple was once a small company, too. In fact, it was co-founder Steve Wozniak who built the first Apple computer by hand. And before Wal-Mart became the world’s largest public company by revenue, founder Sam Walton’s first store was called “Walton’s Five and Dime.”

The point is, every successful company has humble beginnings. We aren’t quite looking for companies in their infancy, mind you. But the earlier you can get in as an investor, the better. The goal of today’s Inside the Numbers isn’t necessarily to find the next Apple or Wal-Mart (although that would be nice), but rather to find small, established, financially healthy companies that are poised for substantial growth in the years ahead.

StreetAuthority’s research team got to work looking for small-cap winners using the following criteria:

  • Companies operating in the United States
  • Market cap between $150 and $2 billion
  • Price/Earnings-to-growth ratio (PEG) ratio below 1.0
  • Operating margins above 20%
  • Profitable last quarter and on a trailing twelve-month basis

It’s important to note that we narrowed our search down to small caps with PEGs below 1.0. This way, we’re not paying an excess premium for growth — we’re actually getting a discount. Operating margins and profitability are important, too: we want small-cap companies that have already staked their claim and are just beginning to enter their prime.

Here’s what we found:

Company (Ticker)

Business P/E PEG Operating margin Market Cap
Deckers Outdoor
(Nasdaq: DECK)
Footwear & Apparel 14.8 0.62 22.4% $1.71B
Syntel Inc.
(Nasdaq: SYNT)
Computer Services 14.7 0.99 29.9% $1.69B
Tessera Tech.
(Nasdaq: TSRA)
Semiconductor Equipment 11.3 0.60 48.0% $1.09B
Impax Labs
(Nasdaq: IPXL)
Medical-Generic Drugs 18.2 0.36 23.8% $1.07B
American Public Educ.
(Nasdaq: APEI)
Education 36.2 0.80 26.8 $845M
GT Solar Intl.
(Nasdaq: SOLR)
Electric Semiconductors 11.4 0.33 26.5 $803M
True Religion Apparel
(Nasdaq: TRLG)
Apparel 15.4 0.47 25.0% $747M
(Nasdaq: GXDX)
Medical Testing Services 22.4 0.79 29.2% $665M
Neutral Tandem
(Nasdaq: TNDM)
Telecom Services 13.8 0.67 37.8% $563M
Questcor Pharma. (Nasdaq: QCOR) Therapeutics 21.3 0.58 46.7% $527M
NVE Corp.
(Nasdaq: NVEC)
Semiconductors 19.5 0.78 56.7% $218M

All of the stocks in the table above make for compelling candidates worth investigating further, but let’s take a look at a few of the standouts:

#-ad_banner-#– Deckers Outdoor (Nasdaq: DECK) makes active wear and casual shoes. Its flagship line, UGGS Australia is responsible for about 85% of revenue. UGGS makes comfortable, casual (and pricey) sheepskin boots that can be worn throughout the year. Chances are, you’ve seen a few Hollywood starlets sport the boots when they’re snapped by the paparazzi — or at the very least your wife, girlfriend or daughter is familiar with the brand.

There are a number of factors that make Deckers shares interesting: The stock trades for 15 times earnings, compared with an industry average of 29. Analysts expect the company to grow earnings more than +22% in the next five years. The stock could represent a solid growth bargain.

True Religion (Nasdaq: TRLG) is another fashion brand. The company makes premium (read: expensive) jeans and casual wear sold in department stores and boutiques. Retailers were hit hard during the downturn, but you wouldn’t know it by looking at True Religion’s stock price, which has almost doubled in the past year. Earnings have been solid and analysts expect the company to continue to grow, yet investors are only assigning it a PEG of just under 0.5.

Impax Labratories (Nasdaq: IPXL) is a generic drug maker specializing in controlled release medicines. I’ve made the bullish case for generic drug makers before, and it’s the same for Impax: An aging population, plus more insured people, plus the impending patent cliff, plus an emphasis on controlling costs all equal more money spent on generic drugs.

Impax markets a generic version of the attention deficit disorder drug Adderall XR and, in March, received approval from the Food and Drug Administration to market its generic version of the blockbuster drug Flomax, which treats enlarged prostates.

Aside from long-term trends, the company has another factor working in its favor: size. It’s just large enough to compete with the name-brand drug giants, but small enough to where it’s still generating top-line growth with each new drug. And if that weren’t enough, Big Pharma and large generic competitors like Teva Pharmaceuticals (NYSE: TEVA) have been on a buying spree lately. With each new Impax generic drug threatening to dethrone a blockbuster coming off patent protection, the company becomes more and more enticing as a takeover target.

Analyst estimates were blown away when fourth-quarter sales grew by more than +400% from a year earlier to $176 million, while earnings grew by more than +300%. to $38 million. The company reports 2010’s first-quarter earnings on May 4th — don’t be surprised to see more big numbers.