Two Small Stocks with Big Gains?

06/10/2010 10:44 am EST

Focus: STOCKS

James Oberweis

President, Oberweis Asset Management, Inc.

James Oberweis, editor of The Oberweis Report, says it’s a good time to buy smaller growth stocks, and he recommends two he thinks could produce good returns.

Today’s interest rate environment is about as good as it gets. In our view, the odds are extremely high that a broad equity portfolio will return at least 6% over long periods of time.

Times in which median [price/earnings ratios drop] far below the historical average (i.e., November 2008) have tended to be particularly favorable times to buy small growth stocks, while times in which P/Es jump far above the historical average (i.e., February 2000) have tended to be quite dangerous.

Today’s valuations are not expensive relative to historical averages. Indeed, P/Es appear undervalued, albeit considerably closer to norms than they were during the November 2008 fire sale. In our experience, [when] the economy emerges from recession, we should see valuations trade above historical averages, as analysts tend to be late in bringing up earnings estimates following a bad period.

That has not occurred so far, implying that continued recovery could yield very significant gains to come. There are still very real risks to that recovery, though data appear to support the case that the worst is behind us.

With a cost of capital of close to nothing, investors can afford to buy stocks and wait it out. Even without betting on robust gains in equities, we believe that those still sitting on cash will likely miss the boat.

Diamond Management & Technology Consultants (Nasdaq: DTPI) is a management and technology consulting firm [that] helps organizations worldwide understand and leverage information, information analytics, and information technology to realize value in their businesses.

Recognizing that information and technology increasingly shape market dynamics and corporate performance, Diamond’s small teams of experts work across functional and organizational boundaries to improve clients’ growth and profitability. The company also provides proven execution capabilities.

In the company’s latest reported fourth quarter, sales increased approximately 42% to $59.5 million from the fourth quarter of last year. Diamond reported earnings per share of [11cents] in the latest reported fourth quarter, versus [two cents a share in last year’s fourth quarter]. (The stock closed above $9 Wednesday—Editor.)

Power-One (Nasdaq: PWER) manufactures energy-efficient power conversion and power management solutions in two primary business segments, traditional power products, and renewable energy.

Recent strong growth has come from the renewable energy market, to which Power-One supplies the inverters that are required by wind- and solar-powered electricity generation systems to convert electricity and feed it back to the grid.

In the company’s latest reported first quarter, sales increased approximately 52% to $152.4 million from the first quarter of last year. Power-One reported earnings [of nine cents] per share in the latest reported first quarter versus a loss in the same quarter of last year. (The stock closed above $6.50 Wednesday—Editor.)

(Full disclosure: Clients of Oberweis Asset Management own shares of both stocks.)

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