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These 5 Small-Cap Stocks Should Be On Your Watchlist

 June 08, 2012 12:32 PM

(By David Sterman) To hear from Wall Street traders, the "machines are taking over the world." These stock jockeys lament that computer-driven trading programs now account for 60%, 70% or even 80% of daily trading volume on the major markets, by some estimates. It's not just the professional traders that feel the pain. Individual investors can see their holdings decimated when the machines decide to issue sell orders across the board -- regardless of company-specific fundamentals. 

The pain can be especially deep for small cap stocks (which I define as having a market value between $250 million and $1 billion), as their lower trading volumes can make them vulnerable to sell orders of as few as 5,000 or 10,000 shares. As a result, there are many small caps stocks that have been plundered in this market.

[Related -Vera Bradley, Inc. (VRA): Don't Miss 50% Upside Because Of Short Sellers]

Some surely deserve to be sold off. Logically, a slower economy will take a bite out of future growth prospects for many companies. Yet this is also a good time to re-focus on the newly-cheaper small caps that still possess bright futures. If the market rebounds, they could score robust gains. Here are five small cap stocks in my sights right now.

[Related -Stocks End Higher Before Payrolls Data; Verifone Systems Inc. (PAY) Sinks]

1. Wabash National (NYSE: WNC)
The nation's roads are filled with tractor-trailers, and even as the tractors (i.e. the trucks pulling the load) wear out, so do the trailers. Wabash is a leading provider of trailers and has recently noticed an upturn in demand as a replacement cycle kicks in. First-quarter sales of $278 million were roughly 25% higher than a year ago. Management's comment on the quarterly press release: "This continued healthy demand environment, coupled with a strong backlog of approximately $583 million as of March 31, 2012, reaffirms our belief that we remain in the early stages of a trailer replacement cycle that we believe could turn out to be one of the strongest in history."

Investors, pushing this stock down to a recent $6.50 from $11 in February, obviously have their doubts about such a bullish outlook. They're seemingly oblivious to the fact that analysts expect Wabash to boost earnings per share (EPS) 300% this year to around $1, and another 50-60% in 2013 to around $1.60. Do shares deserve to trade at just four times that 2013 forecast? Even if you assume the forecasts are too aggressive, and 2013 EPS comes in closer to $1 in 2013, this is still a remarkably cheap stock.

2. Newpark Resources (NYSE: NR)
This company sells and rents a wide range of equipment used by energy exploration firms, including items such as drilling fluids, drilling mats and environmental remediation services. 

As drilling activity has rebounded in the Gulf of Mexico, so have Newpark's metrics. Sales rose more than 30% in 2011 to $958 million, while EPS surged 60% to $0.80. But it's a cyclical business, and the company's cycle is settling down from previous expectations of continued very strong growth to merely good growth in 2012. First quarter sales rose 29% (to $262 million), slightly below expectations of growth in the low 30s. Moreover, profit margins slumped a bit, leading to EPS of $0.16 that was a nickel shy of forecasts. As a result, EPS likely remains stuck in the $0.70 to $0.80 range for 2012 and likely again in 2013. Still, the stock's move to below $6 now from $10 just a few months ago overly discounts the cooling off: Shares trade for less than eight times trailing and forward earnings.

3. Netspend (Nasdaq: NTSP)
I profiled this financial services company nearly a year ago, and though shares went on to post a solid rally, they've been knocked back down by this challenging market. 

Since my bullish outlook last September, Netspend's quarterly results have been even stronger than I would have guessed. First-quarter sales rose 19% to $91 million, and the company appears set to continue boosting EPS at a 15% clip. 

Netspend's shift toward direct deposit accounts is leading to a locked-in customer base that yields a higher degree of recurring revenue. Netspend is also working with more retail outlets such as 7-11, and financial services providers such as Paypal. As analysts at D.A. Davidson note, "Only 5% of current revenues are derived from the retail channel, providing plenty of room for growth." They see shares rising to $12, or 9.5 times projected 2012 EBITDA.

4. Vera Bradley (NYSE: VRA)
This handbag maker was a hot IPO that has now been taken out to the woodshed. Growth cooled a bit and IPO investors that had been expecting continued scorching growth felt burned. I'd explain why I think this stock is due for a rebound, but my colleague Ryan Fuhrmann has already done a nice job, which you can read about here.

5. iRobot (Nasdaq: IRBT)
This technology firm has shed nearly half its value in the past 52 weeks, reducing it from being a mid-cap stock to a small-cap in the process. The blame for that falls on concerns about the company's defense segment, which provides automated mobile devices that can be used in environments that are too risky for soldiers. 

Yet investors may be overlooking the fact that iRobot's consumer business, which consists of vacuum cleaners, gutter washers and other devices, is quite healthy. So healthy that iRobot recently delivered estimate-topping first-quarter results for the fourth straight quarter.

To be sure, the defense slowdown hurts. EPS is likely to fall by a third this year to around $0.95. But continued strength in the consumer business is expected to boost EPS back up to around $1.25 in 2013. This was once a high multiple stock that can now be had for around 17 times projected 2013 profits. And despite recent failings, the defense business shouldn't be overlooked either. The sector is in consolidation mode, and iRobot has been rumored as a buyout candidate.

Risks to Consider: These are high-beta stocks, which can work against them in a falling market.

Action to Take --> It's always wise to maintain watch lists on your favorite growth stocks. They will occasionally stumble, which makes for a nice entry point for patient investors. These small cap stocks should be on your list.

-- David Sterman

David Sterman 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.

This article originally appeared on StreetAuthority
Author: David Sterman


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