Four Stocks for the Small Business Rebound

by: StreetAuthority

By David Sterman

Voters across the political spectrum can agree on at least one thing: the long-term health of the U.S. economy absolutely depends on jobs being created by the private sector. So last Friday's report that 64,000 private sector jobs were created is a hopeful sign, though clearly not enough.

The chart below shows the depth of pain being experienced by small businesses.

(Click on image below to enlarge)

But even as last Friday's jobs report may not yet signal a big upturn in hiring, a few other items in the news on Friday suggest that the private sector may create higher amounts of new jobs in the months ahead.

First, the Treasury Department has just announced plans to provide states with $1.5 billion to help promote small business job creation. States have to prove that the funds are being matched with much higher levels of bank lending, so the whole economic boost is hoped to be closer to $15 billion. And just last week, the Small Business Jobs Act went into effect, creating a $30 billion small business lending fund for community banks and offering tax cuts for small businesses.

Those efforts may help a trend that is already underway, if little-known ScanSource (Nasdaq: SCSC) is any indication. This company sells a range of telephone, barcode scanning and point-of-sale equipment to small and medium-sized businesses. Large companies buy these wares direct from the manufacturer. Thousands of smaller companies need to go through middlemen like ScanSource. At the end of every quarter, the company discusses recent sales trends -- and right now, business is doing quite well.

Sales in the first fiscal quarter rose to around $625 million from $488 million a year ago, well ahead of the $567 million consensus forecast. That's pushing shares up +7%, close to a 52-week high, which makes me hesitant to recommend shares of ScanSource in particular. But it's a clear sign that other companies selling into the small and mid-sized business (SMB) sector have increasing reason to cheer. Here are three names I like as SMB plays:

Office Depot (NYSE: ODP)

The tough economic environment has been brutal for this office supply chain. Adding insult, rival Staples (Nasdaq: SPLS) has been a far more nimble player, stealing away market share. Office Depot's stock has fallen from $35 in 2006 to a recent $4.50, but as I noted recently, that seems like too deep of a punishment.

Make no mistake, Office Depot has its work cut out for it. The retailer needs to further pare debt, figure out a way to retake market share, even as firms like Walmart (NYSE: WMT) step onto its turf, and weather the effects of the downbeat economies in Florida and California, where the store base is heavily concentrated. But I'm heartened by recent insider buying, improving working capital metrics, very cheap valuations and, as noted above, a possible strengthening in the SMB sector. And as I noted in this article, retailers only need to show modest sales gains to post outsized cash flow gains.

Mitel Networks (Nasdaq: MITL)

This $14 IPO is now a $6 busted IPO. Shares are now quite cheap, trading for less than seven times projected fiscal (April) 2012 profits. The dead-on-arrival IPO came public in the wrong year, as it's a play on the SMB sector, which up until now, has been in a funk. Mitel sells phone systems and usually sees demand when companies are hiring, with new desk set-ups. But even with sales at depressed levels, Mitel can still be counted on to earn $0.75 to $0.90 a share. If SMB spending really picks up, per share profits could exceed $1.

Vistaprint (Nasdaq: VPRT)

The big slowdown in SMB spending really hurt this company, which provides printing and marketing services to companies that are too small to handle their printing needs on an in-house basis. Shares plunged in early August, which looked to me to be a severe over-reaction.

Analysts at Kaufman Bros. see shares rebounding back from a recent $37 to $50 as the company's sales problems this summer prove to be short-lived. "Vistaprint is currently facing a perfect storm, with small business weakness, adverse (foreign exchange) impact and recent execution issues. We note that all these factors are temporary, and should reverse themselves in the future," notes Kaufman's analysts. They predict that shares, which currently trade for 13 times next year's profits, will trade up to a price-to-earnings (P/E) multiple of 20 once these near-term concerns abate.

Spending at small businesses is likely to rebound only slowly into 2011 and perhaps more robustly into 2012. But investors need to look ahead, and these stocks could start to appreciate handsomely, simply on the expectation that SMB spending will eventually rebound -- and the stocks I mentioned above are good places to start.

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

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