3 Small Caps Showing Leadership

10/12/2011 8:30 am EST

Focus: STOCKS

Kate Stalter

CMO & Senior Financial Advisor, Better Money Decisions

It’s not unusual for small caps to lead the way in a fledging rally, writes MoneyShow.com contributor Kate Stalter, who tracks three smaller companies exhibiting upside strength as they work their way toward new price highs.

In the recent market rallies, small caps have led the way. That’s not unusual to see. In March 2009, when the indices emerged from the bear market, many small, thinly traded stocks with dodgy fundamentals were among the early price leaders.

Lack of liquidity means prices in some of these thin stocks can rocket higher quickly, whereas more stable, widely held big caps often post more modest gains in a bull market.

Small caps have notched some of the best price gains within the S&P 500. However, as an investor who prefers to avoid bottom fishing, many of these benchmark index small-cap components have sustained too much damage, and are not catching my eye as investment candidates.

Among the bunch, the best technical performer, in terms of moving average support, is Nicor (GAS), which is holding above its 50-day and 200-day lines, as well as shorter-term price lines.

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But Nicor’s fundamental picture isn’t inspiring much confidence. In addition to an erratic history of earnings growth, the company is expected to show a profit decline in 2011, to $2.49 per share, down 4%.

Because upside price momentum is currently in its favor, Nicor may have potential for traders or investors willing to exit quickly if the stock comes under selling pressure. Watch for it to overcome resistance between $56 and $57 in heavy volume. That could signal further gains in the stock.

Because it’s a dividend-paying utility, it’s held up fairly well in the volatile market, as investors flocked to companies yielding a payout, and those they perceived as offering necessary products and services. In stronger market conditions, utilities are not typically among the best performers.

In the 2009 uptrend, many of the early strong performers were little-known names, at least at that time. In my scans of current small-cap leaders, gunsmith Sturm & Ruger (RGR) is zeroing in on its target.

The stock caught my attention because it’s attempting to climb out of a price consolidation, and the earnings estimates indicate growth. Wall Street sees earnings of $1.72 per share this year, a gain of 18% over 2010.

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Unlike other stocks, Sturm & Ruger didn’t undercut the low of its prior consolidation when the market pulled back in August. However, it came with pennies of its previous buy point out of the earlier pullback. Generally speaking, a big pullback, particularly as the general market is weak, can flush out traders and investors lacking in conviction, and clear the way for new buyers who grab shares at a bargain.

Sturm & Ruger has some work to do if it is to approach its all-time high of $36.85, reached in August. I’ll also be looking for better upside volume as a sign that institutions are getting on board.

The company reports its third quarter on November 2, so that could be a catalyst for a bigger price move. Wall Street expects earnings of 41 cents per share; the company has beaten earnings estimates in each of the past four quarters.

Liquidity Services (LQDT) is a small cap that’s been bobbing and weaving above its ten-week line and below its previous price high.

The online auctioneer of wholesale and surplus goods has an excellent consensus outlook. Analysts expect the company to grow earnings 42% in 2011 and 24% in 2012. Those are the kinds of numbers that tend to attract institutional buying.

The stock fell below its ten-week average in August, during the general market selloff. However, it rebounded in enormous volume on September 1, zooming more than 30% on news that it would acquire Jacobs Trading’s consumer-goods remarketing business for $140 million plus some performance-based considerations.

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Jacobs manages excess inventory for manufacturers and retailers, a model that fits with Liquidity Services’ existing business.

Traders and investors liked the deal because it would boost Liquidity Services’ exposure to Wal-Mart (WMT). In the past, announcement of Wal-Mart deals has spurred price gains in many a stock, including Cal-Maine Foods (CALM) and Green Mountain Coffee Roasters (GMCR).

Upside volume trends have been positive for Liquidity Services’ stock, as it’s notched big price gains on heavier-than-average volume.

The company’s market cap is just $886 million, and the stock trades 423,000 shares a day.

As with other stocks I’ve mentioned in this column, watch for it to approach its previous price high in heavy volume. I’m encouraged by the way it’s been holding above its ten-week line recently, and that downside volume has been on the lower side recently.

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