By David Sterman
With the Federal Reserve standing pat this week, the S&P 500 index has reached another all-time high.
Yet this bull market is proving to be even more fertile for investors in small-cap and micro-cap stocks. Both the iShares Russell Microcap Index and the Russell 2000 Small Cap Index are outperforming the S&P 500 by a solid margin over the past two years.
Click to enlarge
With no end in sight to the bull market, there's no reason to stop focusing on these small companies at this juncture. If the economy can manage to build a head of steam in 2014 and 2015, then these small stocks should see even deeper investor interest.
Here are three stocks that all trade below $5 and sport market values below $500 million -- and are poised for solid upside if this rally continues.
1. Lionbridge Technologies (LIOX)
I took note of heavy insider buying at this language translation services firm back in July, and though shares are up nearly 10% since then, the company's outlook has brightened markedly.
On the second-quarter conference call, management delivered its most upbeat discussion of business trends in several years, noting that Lionbridge is seeing an expansion in its relationship with Microsoft (MSFT), the return of several other large tech clients that had dropped off in the past few years, and a rising order book with manufacturing and life sciences clients.
The charm of this business model is the clear need it fills. Companies are looking to make sure their staffs in foreign offices are able to correctly translate documents, provide accurate sales brochures in local languages, and conduct videoconferences in multiple languages. As an example, Intuit (INTU) is now using Lionbridge's GeoFluent simultaneous translation software at its global help centers, as are a dozen other clients.
Much of this new business activity has yet to bolster the income statement. Indeed, sales are likely to rise at less than 10% (on a year-over-year basis) in coming quarters, but the seeds appear to be in place for more robust growth as the global economy mends. I encourage you to read the management discussion to gain a deeper sense of Lionbridge's growth prospects.
2. Novavax (NVAX)
At some point early in your life, you probably picked up a case of RSV (respiratory syncytial virus). Most babies do, and then go on to make a full recovery. But for babies who have compromised immune systems, especially those who are born premature, RSV can be lethal. Worldwide, roughly 3 million kids and at-risk elderly people are hospitalized each year, leading to an estimated 66,000 deaths.
Doctors will be convening in Portugal next month to discuss the latest approaches to treating RSV (there is currently no vaccine). While several biotech firms are working on the problem, "Novavax leads the field," according to analysts at Lazard. The company is expected to discuss its current clinical trials at the event, which may explain why this stock has already been perking up lately.
Click to enlarge
The RSV meetings are just a near-term catalyst for this stock. Long term, Novavax is pursuing a vaccine for the herpes virus, bird flu and even the seasonal flu virus.
Those potential market opportunities explain why Novavax's market value has already swelled to nearly $500 million. Yet analysts at Lazard see more than 200% upside to their $11 target price. They view the company's drug development and approval as a "when" and not "if" situation.
Management will be holding a detailed discussion of the drug pipeline next week, making this a good time to brush up on this under-the-radar biotech investment opportunity.
3. Merge Healthcare (MRGE)
A friend of mine is a speech pathologist at a well-regarded New York City hospital, and she's had a stressful summer. Virtually every staff member at her hospital has had to pause from their work to brush up on a looming health care mandate, known as ICD-10. It's an online coding system that will enable better portability of a patient's medical records.
But the transition is already causing industry headaches. Leading hospitals have frozen any new purchasing decisions so they can focus on ICD-10 implementation, leading to a weak second quarter at this digital imaging vendor. Merge delivered what it called "very disappointing results," citing "a continued reluctance amongst large health systems to move forward with enterprise purchases."
A new management team was brought in at the time, and a few weeks later, on Aug. 26, Chairman Michael Ferro resigned.
But Ferro has an ulterior motive. He's not abandoning a sinking ship -- he wants to avoid any conflicts of interest as he finds ways to boost shareholder value.
"I do not believe that the current trading price of Merge common stock reflects the company's inherent strengths, market position or long-term prospects," Ferro noted at the time, adding that "I intend to explore a variety of ways to increase shareholder value, including, possibly, a going-private transaction."
Since then, shares have been steadily rising, thought they remain well below the $4.50 level seen earlier this summer.
Click to enlarge
Despite the near-term revenue pressures, Merge is actually very well-positioned for the move to digital health care. The company's software modules capture a range of images such as X-rays, and store them in interoperable formats that can be used at both major hospitals and local doctor's offices. It's not often you find a software provider trading at 1 times sales, and a return to growth or a company buyout would lead that multiple to expand higher.
Risks to Consider: Small-cap and micro-cap stocks would be among the hardest hit in any market slump.
These stocks are starting to trend higher but have ample upside if they can deliver on the business plans in front of them.
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.