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While much of the stock market is quite efficient - meaning information is well distributed, and so it is hard to get an edge and outperform - there are certain niches that are less efficient. As I've often said, turnaround investing stocks represent one of those inefficient niches because they require a mindset that most mainstream analysts don't have. Small-capitalization stocks can also be less efficient. Their small size and lower levels of trading liquidity make them impractical for large investment funds to own, and so there are fewer analysts following them.

If you combine these two sources of inefficiency, it stands to reason that small-cap turnaround stocks should be particularly inefficiently priced. Since inefficiency usually equates to abnormally high return potential, that makes these stock picks particularly interesting. The stocks described below are culled from the worst performers in the S&P SmallCap 600 this past year. They all have solid businesses, decent balance sheets and good rebound potential.

Small Caps with Big Rebound Potential

Company

Symbol

Recent Price

52-Week Range

Market Cap. Mil.

YTD% Change

Div. Yield

Arkansas Best

ABFS

9.28

22.79 -6.43

238

-51.84

1.3%

Blyth

BTH

14.80

46.15-14.01

252

-47.89

1.3%

Electro Scientific Ind.

ESIO

9.79

17.00-9.28

288

-32.39

3.3%

Harte-Hanks

HHS

5.92

10.24-5.14

372

-34.87

5.7%

Heidrick & Struggles

HSII

15.31

23.95-11.12

275

-28.92

3.4%

NutriSystem

NTRI

7.86

15.55-7.21

217

-39.21

8.8%

Quality Systems

QSII

17.04

45.00-15.04

1,010

-53.93

4.1%

Questcor Pharm.

QCOR

27.78

58.91-17.25

1,630

-33.19

2.7%

Arkansas Best (ABFS) derives the bulk of its revenue from trucking operations. The industry did okay coming out of the last recession, but more recently, concerns about slowing economic growth have led investors to abandon Arkansas Best. The company's unionized labor force can be a pricing disadvantage, but management is taking other steps to remain competitive. Arkansas Best is also expanding into other services such as logistics offerings.

Blyth (NYSE:BTH) uses direct selling, catalog and Internet and wholesale programs to sell a number of consumer products, such as candles, decorative accessories and certain food items. The stock was on a good growth track through August. The canceling of a planned IPO for the company's ViSalus subsidiary in September started a sell-off that has continued to year-end. Recent business results have been bumpy, perhaps because of the distractions relating to ViSalus, but there is good potential for a rebound in 2013.

Electro Scientific Industries (NASDAQ:ESIO) supplies laser-based solutions that enable precise manufacturing and testing of electronic devices, semiconductors, LEDs and other high-value components. Management is using the firm's strong intellectual property to build out the product line. The balance sheet isn't an impediment, as cash and short-term investments totaled $172 million at the end of Q2 (March fiscal year). General economic weakness may crimp near-term gains, but the company has ample growth opportunities as it transitions to a broad-based laser micro-fabrication company.

Harte-Hanks (NYSE:HHS) provides direct marketing services and shopper advertising opportunities. The loss of J.C. Penney, which moved to more television advertising, was a blow, but the company has a diverse customer and geographic base. Management is working to keep the company relevant in the digital age with social media and email marketing. A decision to sell its Florida shopper unit, The Flyer, will bolster the balance sheet. A strong dividend that looks sustainable and some insider buying create an enticing package.

Heidrick & Struggles International (NASDAQ:HSII) is a leading executive search and consulting company. A weak earnings report in July pushed the stock down sharply, and management's decision to cease providing annual guidance did little to reassure Wall Street analysts, who like to have everything clearly laid out for them. Management has done a good job of keeping up with the rapidly changing nature of the skilled professional in the digital age. With executive talent becoming more important than ever, and the search market becoming more global, Heidrick is well positioned for long-term growth.

NutriSystem (NASDAQ:NTRI) is the number one home delivery weight loss company. A string of quarters with declining revenue and profitability reflect, in part, the sluggish economy coming out of the last recession. The weak results led the board of directors to bring in a new CEO in November. The company is also introducing some new products and pricing strategies. We can't vouch for the sustainability of the dividend, but it certainly looks mouth watering at the moment.

Quality Systems (NASDAQ:QSII) provides healthcare information systems used in automating medical and dental records. Having been around since 1974, the company is one of the more experienced providers in the sector. Questions about revenue timing, competitive threats and the loss of an important contract caused the stock to swoon in July, but it has since stabilized. Management continues to invest in R&D as well as develop strategic partnerships, including a recent deal with Microsoft. Increasing federal and state regulation of medical records, as well as the ongoing push for efficiencies in healthcare, create good long-term prospects for this business. No debt, ample cash, free cash flow, and an attractive dividend make Quality Systems particularly interesting.

Questcor Pharmaceuticals (QCOR) is a biotechnology company with one primary drug, Acthar. It is currently approved in the U.S. for the treatment of acute exacerbations of multiple sclerosis in adults and for the treatment of infantile spasms in infants and children under 2 years of age. The stock took a dive in July when Aetna reduced its coverage for certain types of infantile spasms. Other insurers have failed to follow suit, however, and so the impact on Acthar should not be that significant. The company also has new products in development. A bit of insider buying in November combined with solid financials and a new dividend make the stock appealing.

Source: Small-Cap Turnaround Stocks With Big Rebound Potential