Growth Is Back: 7 Small Caps

12/06/2010 12:21 pm EST

Focus: STOCKS

James Oberweis

President, Oberweis Asset Management, Inc.

James Oberweis, editor of the Oberweis Report, predicts smaller stocks with the best growth prospects will win out next year as the market runs into tougher comparisons.

If we have been through the worst of the crisis, where are the opportunities today?

Our research indicates that price/earnings ratios for small-cap growth stocks remain modestly below average, but substantially higher than 2008 crisis levels and well within the “normal” range.

[The Russell 2000 small-cap index is up 27% since Aug. 24. Near those summer lows, Todd Salamone and Elizabeth Harrow predicted great things for the smaller fry, citing in part their resilience to bad news from overseas—Editor.]

In periods when overall stock market valuations appear fair, the prudent investor must find value at the individual company level, as simply “buying the market” will not be enough to generate superior returns.

Furthermore, the “rebound game” will be over in 2011. It won’t be enough to buy businesses with revenues bouncing off the abysmal depths of 2009. 2011 will be about growth stocks that are growing because they have unique products or services driven by customer demand. It may be worth paying a premium for growth companies with a very clear path toward driving increases in revenues and expanding margins along the way, even if the overall economy exhibits only a modest increase.

7 Picks for After the Bounce

Indeed, we think that investors will pay an increasing premium for growth when year-over-year increases become more difficult to find. Here our favorite issues.

In the consumer sector, large-format movie company Imax (Nasdaq: IMAX), paisley fashion bag producer Vera Bradley (Nasdaq: VRA), and Green Mountain Coffee Roasters (Nasdaq: GMCR), which makes single-cup Keurig coffee machines, win out as our favorites.

In technology, Acacia Technology (Nasdaq: ACTG), MIPS Technologies (Nasdaq: MIPS), and capacitor maker Kemet (NYSE: KEM) have the honors. Acacia buys patents and licenses them for royalties or sues to enforce them. MIPS Technologies makes industry-standard processors for applications like digital TVs, set-top boxes, and WI-FI access points and routers. MIPS’s opportunity in 2011 will be to go from the digital TVs and routers to mobile phones. Because of the open-source design of the Android phone, MIPS has a good chance to dislodge archrival competitor ARM Holdings (Nasdaq: ARMH) from its monopoly on core processor designs for mobile phones.

We’re finding fewer interesting ideas in health care, though HMS Holdings (Nasdaq: HMSY) continues to look attractive and is benefiting from rising Medicaid enrollment. These ideas highlight some of the fastest growing small-cap companies available. These are companies that are poised for growth, even as growth becomes harder to find in 2011 as year-over-year comparisons become more challenging.

[Don’t have the time to research small-cap winners? Morningstar FundInvestor recently profiled a little-known but very successful small-cap fund focusing on reasonably priced growth stocks—Editor.]

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