Two Small Growth Stocks for Hard Times

02/11/2009 12:00 pm EST

Focus: STOCKS

James Oberweis

President, Oberweis Asset Management, Inc.

Jim Oberweis, editor of the Oberweis Report, finds two stocks that have businesses strong enough to profit during the economic crisis.

2009 may be the opportunity of a lifetime to buy small-cap growth stocks. With valuations for small-cap growth stocks at among the lowest levels in 30 years and investor expectations far more modest, a small improvement in fundamentals could spark a significant increase in stock prices. That said, the risk remains that things don’t improve anytime soon.

In tough economic times, most companies are hit by weaker consumer demand. But a few companies benefit from the bad economy, [while] others operate in niches that are resistant to the bad economy. From our portfolio, here are [some] examples.

HMS Holdings (Nasdaq: HMSY), a provider of insurance benefits coordination for government-sponsored health care programs, actually benefits from rising unemployment.

Its biggest client, Medicaid, is a government insurance program for low-income people with no other insurance. HMS makes money by finding errors in the processing of medical payments and identifying claimants who have additional insurance but didn’t say so.

As the ranks of Medicaid grow along with unemployment, the market for HMS expands as well. The risk: It is hard to gauge how President Obama’s [stimulus] plan will affect state health insurance programs.

We expect HMS to grow earnings 35% over the next year. [At Tuesday’s close above $33,] shares trade for 35x our forward estimate of 93 cents a share.

In our second case, certain companies have carved out niches that are only minimally influenced by a tight economy.

In our hometown of Chicago, Neutral Tandem (Nasdaq: TNDM) operates a telecommunications network that connects traffic flowing across the networks of more than one telecom carrier. For example, if AT&T Wireless wants to route a call to a destination that ends on a Comcast cable network, they have to pay their competitor–the local telephone company—a juicy fee to route the call through their tandem switch.

Neutral Tandem offers competitive local carriers, wireless carriers, and cable companies a way to bypass the Baby Bells when exchanging calls and data with each others’ networks. Neutral Tandem claims their fees are much less than those charged by the Baby Bells, and the money doesn’t end up in the pockets of their competitors. TNDM says that most major networks are connected to their switch, creating a significant long-term barrier to entry for competitors.

[At Tuesday’s close above $19,] shares trade for 21x our forward estimate of 90 cents [a share] in the next 12 months, which represents 55% growth in earnings.

Despite challenging economic headwinds, certain smaller companies will defy expectations by finding unique niches with high barriers to entry. Companies like HMS Systems and Neutral Tandem appear to be thriving, even while most companies are struggling to hold ground. These companies, which are still growing quite robustly, should trade at a premium during difficult economic times like today.

Subscribe to the Oberweis Report here…

Related Articles on STOCKS