Two Small Growth Stocks Ready to Shine

11/10/2009 12:00 pm EST

Focus: STOCKS

James Oberweis

President, Oberweis Asset Management, Inc.

Jim Oberweis, editor of the Oberweis Report, says small growth stocks should easily beat the market, and he finds two he thinks should outpace tepid economic growth.

We can’t remember a time when so many chief executive officers told us that conditions appear to be improving (albeit from the depths of Hell). At the same time, we also can’t recall a time when the government printed money this fast and gave it away even faster.

To sum it up, it seems like things are getting better, but we wouldn’t recommend betting more than a lunch on it. If we are right, then we are in for a multiyear period of mediocre economic growth in the US, and stock valuations are no longer the special bargain they were back in March. It won’t be enough to “own the market.”

Astute investors will gravitate toward equities with the potential to shine—those able to grow at rates faster than the unexciting increase in GDP. That should play to our strength. While we expect tepid real returns (after inflation) for the broad equity market over the next few years, we believe that the opportunity for innovative smaller companies may be above average. Investors will eventually pay a premium P/E multiple for growth stocks when growth isn’t easily found elsewhere.

Cabot Microelectronics (Nasdaq: CCMP) is a leading supplier of high-performance polishing slurries and pads used in the manufacture of integrated circuit devices within the semiconductor industry, in a process called chemical mechanical planarization (CMP).

CMP polishes surfaces at an atomic level, enabling a semiconductor manufacturer to produce smaller, faster, and more complex IC devices with fewer defects. Cabot also manufactures CMP slurries for polishing certain components in hard disk drives.

In the company’s latest reported fourth quarter, sales increased approximately 7% to $96.5 million, from $90.2 million in the fourth quarter of last year. We expect revenue growth to accelerate in the coming quarters. Cabot reported earnings per share of 52 cents in the quarter, versus 39 cents in [last year’s] same quarter. (The stock closed above $32 Monday—Editor.)

Alpha Pro Tech (Amex: APT) reported revenue growth of 65% and earnings growth of 300%, mostly attributable to strong sales of N-95 respirator masks to protect against H1N1 (swine flu virus).

APT trades for only ten times our 2010 earnings estimate, implying that most people think that N-95 mask sales will evaporate once H1N1 fades away. We believe that sales will persist longer than many people believe. The publicity around H1N1 may ignite a round of mask stockpiling for future adverse events. (The stock closed above $6.50 Monday—Editor.)

While we are not broadly confident in the future of US growth, we are certain that tiny pockets of growth via companies like APT will evolve. Buying those companies with a proven ability to deliver great quarterly earnings gives us slightly higher confidence that business momentum is trending in the right direction.

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