3 small-cap bargains ready to rocket

These stocks are oversold and underappreciated amidst pricier brethren.

By Traders Reserve Oct 29, 2013 1:31PM

Image: Stock market (© Comstock)By Karen Riccio


The Russell 2000 index of small-cap stocks closed at a record high late last week, its 56th time this year, doubling the performance of the Standard & Poor's 500 Index ($INX) since April -- 20% versus 10%.


That’s great news for investors who already own positions in this arena, but not so good news for those who don’t.


The performance run-up in small caps has made them fairly pricey as far as valuation goes. The price-to-earnings ratio of the Russell 2000 is above 18, exceeding its long-term average of 14.9, according to Bank of America.

Considering that domestic turmoil has simmered down for now, you can expect small caps -- which are most prone to volatility when things sour -- to continue their journey higher.


Underappreciated and oversold

The trick is finding small-cap bargains: Companies that haven’t kept pace with their counterparts because of being oversold and underappreciated by investors. Stocks in this category have some catching up to do, and now might be the time to buy at very low prices.

Two of the following three companies are technically oversold according to the Relative Strength Index or RSI. It measures momentum on a scale of zero to 100. If a stock’s reading falls below 30, it is considered oversold.


Here are three bargain small-cap stocks with big potential:


BJ’s Restaurants (BJRI)

According to the RSI, BJ’s is incredibly oversold, especially after dropping as much as 11% after reporting lower-than-expected third quarter revenues. Restaurant sales decreased 2.2% in the quarter. Currently trading at $26, this is a pretty attractive entry point for a company looking to double in size over the next five years.


BJ’s opened 11 new restaurants during 2013, six of which were opened during the third quarter. Its pipeline is fully stocked in anticipation of opening 17 to 19 new locations during fiscal 2014. Criticized for overly expensive opening costs, management says that two-thirds of its new restaurants will be developed under a new prototype. This is expected to save $1 million in building costs per unit.


The stock is down 31.6% this year.


SolarWinds (SWI)

On one hand, this provider of IT management software has been openly criticized for spending over $200 million in cash to acquire two companies in the past five months. On the other hand, SolarWinds has been recently ranked by Forbes as one of America’s Best Small Public Companies (No. 15) and 20 Fast-Growing Tech Stars (No. 6) and named the leader in Application Performance Management software (APM) by IT Brand Pulse.


Its APM software outranked CA Application Performance Management, IBM SmartCloud, Dell Foglight, HP Application Performance Management and CompuWare APM, among others.

After announcing that it would acquire Boulder, Colo.-based Confio, maker of database performance software, for $103 million, SolarWinds’ stock fell 3%. The company also agreed to buy privately held N-able Technologies in May for $120 million in cash.


Confio and N-able Technologies together earned $50 million in business prior to the acquisition.

Slowing license sales sent shares of SolarWinds plunging in July after it reported Q2 revenue that missed estimates. The Austin, Texas, company's revenue growth has slowed despite eight acquisitions since early 2011. Fourth-quarter revenue is expected to be flat.


SolarWinds stock reached an all-time high of $61.52 on March 14 but has since dropped 45%. Back in July, JPMorgan analyst John DiFucci rated SolarWinds a buy, but lowered his price target to 54 from 73. It is currently trading at $36.67 -- now that’s a bargain.

HMS Holdings (HMSY)

HMS Holdings is another award-winner that’s down 20% year-to-date. The health care coordinator earned a spot on the 2013 “Healthcare’s Hottest” list by Modern Healthcare magazine and the InformationWeek 500, a list that tracks the nation’s most innovative users of business technology.

The “Hottest” annual list recognizes the 40 fastest-growing companies and organizations in the industry. Only companies with a minimum of $20 million in annual revenue in the last fiscal year were eligible. The list includes suppliers like HMS, as well as payers, hospitals and hospital systems, as well as physician group practices.


HMS’s clients include health and human services programs in more than 40 states plus Medicaid and the Veterans Administration facilities. As a result of the company's services, clients recovered more than $3.2 billion last year and saved billions more through the prevention of erroneous payments.


While HMS Holdings is forecasting a weak fourth quarter and won’t announce third-quarter earnings until Nov. 8, it did beat revenue estimates with a 4.77% increase to $125.8 million from the second quarter a year earlier.

After hitting a high of $31.93 this year, the stock currently trades around $20.90.


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