By David Sterman
With the market moving ever higher, investors are "moving out on the risk curve." This means the positive price action is beginning to spread to more speculative stocks -- small- and micro-caps. Indeed, investors can score stunning gains in the micro-cap arena -- if they pick the right stocks.
Of course, whenever you focus upon stocks with significant potential upside, it's wise to keep your enthusiasm in check. The "swing-for-the-fences" approach can be quite rewarding, but it also brings increased risk of an occasional flameout. That's why a basket approach is best. But by owning several speculative plays, with each comprising less than 5% of your portfolio, you may be richly rewarded.
Here are three micro-cap stocks that could generate significant gains in the year ahead.
1. Capstone Turbine (CPST)
Roughly a decade ago, this company was expected to revolutionize the power-generation industry. Its micro-turbines held the promise of providing off-the-grid power back up for many factories. They were also seen as a potential savior for remote villages in countries like India, where electricity was still scarce or even non-exisiting.
Capstone's shares briefly moved above $80 in late 2000, but after a decade of operating losses, shares now trade below $1. In fact, the company generated positive gross margins for just the first time in its history in fiscal (March) 2012.
Yet gross margins are finally starting to move up meaningfully, hitting 9% in the company's fiscal second quarter ended September. When fiscal third-quarter results are released on Monday, Feb. 11, gross margins should reach double-digits for the first time. Analysts at JMP Securities expect gross margins to rise to 13% in the company's current fiscal fourth quarter.
Equally important, the company's turbines are finally seeing the rising demand many had hoped to see a decade ago. Thanks to a 21% jump in orders in the September quarter (compared with a year ago), backlog swelled to a company record $141million, and likely stayed at that level in the December quarter as well.
The shale gas revolution is helping to drive results. Energy-drilling companies are installing the company's micro-turbines right at drilling sites, where they can tap right into the fuel that's being generated. Office towers are also installing them as well. The Palace hotel in New York City recently put a micro-turbine in its basement. In fact, Hurricane Sandy helped to trigger orders for dozens of new turbines, highlighting the company's role in storm-ravaged locations.
Analysts at JMP say Capstone's "backlog growth is progressing nicely and will position the company for solid 30% growth in FY14." The focus for investors, they add, "will likely remain on margins and we expect FY14 to be a critical inflection point for the company to validate its' LT target of mid-30%." Their $1.80 price target is based on the notion that Capstone is "in the very early stages of a multi-year uptake cycle for micro turbines."
2. Abtech Holdings (OTCQB:ABHD)
This is another energy play, albeit more speculative because of its weak balance sheet and a still-low base of sales. Yet the company's technology is quite intriguing.
Abtech's engineers have developed a sponge-like material that may prove to be quite effective in sopping up all of the contaminants produced in the wastewater process of natural gas drilling. The company claims its "SmartSponge" can remove 99.99% of contaminants from fracking wastewater, which could enable gas producers to save considerable money on the back-end, as the massive volumes of water would no longer need to be trucked out, and instead could be discarded locally.
SmartSponge gained a lot of buzz last summer, when it was handed the Third Annual World Shale Oil & Gas Award for technological innovator. Since then, the company has been showing its technology to many natural gas drillers, though none have signed up to use the technology just yet. But Abtech has a five-year deal with Waste Management (NYSE: WM), which plans to use the SmartSponge in treating municipal sewer runoff. This relationship has yet to yield significant revenue, though.
And therein lies the rub. This is a company that burns through a few million dollars every quarter, and will have to keep scrambling to raise money until the day that sales take off. As is the case with many young technology companies, that day may never come. Simply put, that's why this company is worth just $50 million. But if Abtech can gain traction with SmartSponge, then its market value could end up being far higher.
3. Derma Sciences (DSCI)
This company generates roughly $70 million in annual sales from a line of wound care products that are resold by major health care companies on a rebranded basis. But it's the company's DSC127 drug that is set to enter Phase III clinical trials later this year that could really propel this stock far higher. Testing results from earlier clinical trials found that DSC127, when applied to a wound care material, was quite effective in treating people with diabetic foot ulcers.
Derma Sciences is already profitable in its core business, but investments in the development of DSC127 have led to roughly $3 million in quarterly operating losses. A fresh capital raise in December means the company has more than $40 million in cash, which should be enough to cover the operating losses for several years to come. If DSC 127 hits the market, then the company's current $160 million market value could double or even triple in size.
Risks to Consider: Capstone and Derma Sciences have plenty of cash on hand but will need to keep making progress in their development tracks to overcome investors' current wait-and-see attitude. Abtech Holdings is in a far weaker financial position, and will likely need to raise more money in coming months.
Each of these companies is pursing "game-changing" technology, and each one could generate significant sales growth in coming years. But as they also carry significant risk, it's wise to start with small positions and build from there as these business models progress.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.