Will the Next Apple or Google Be Found Among These Micro Caps?

by: Kurtis Hemmerling

There is a certain element of thrill and satisfaction that comes from buying small stocks with a great story. It is the same feeling that scouts get when searching for that next great league player. Trying to find the next big thing can be taxing on both your time and resources.

In addition to the amount of time it takes to investigate small stocks, good ideas are not always financially viable. Large corporations afraid of losing their market share are quick to employ a range of guerilla tactics to quash any new uprisings if they cannot buy them out. While innovation and imagination are the hallmarks of success, the mass public may not turn to new methods until necessity demands it.

For example, I love the concept of having a home roofed in new solar absorbing energy shingles, but Evergreen Solar (ESLR) is about to be de-listed as it files for bankruptcy protection and begins selling its assets. With a current market cap of 6.14 million, it is hard to stand-up to the big boys such as DOW that sells the POWERHOUSE solar shingle. I must admit that every time I see a giant company getting into cheap, green energy - I get a little skeptical such as when GM made the EV1 electric car.

Therefore, take this next list of tiny stocks with a dose of reality. Some might make it big, while others might trade with extreme volatility for their lifetime, or worse...eventually get de-listed. It is up to you to look through each stock to see if its a product you believe in and are willing to go the distance on a great story, a dream, with a dash of fundamental analysis.

Micro-Cap Stocks With a Story
GTXI - It is exciting to contemplate a cure for cancer. Recently in the news, the University of Pennsylvania there are promising results from a leukemia study that engineers assassin T-cells. GTXI takes a different approach with prostate and breast cancer by developing small molecules that attach themselves to estrogen receptors and modulates them for the purpose of stimulating or blocking their activity. It all seems quite complex and I am sure that I cannot sufficiently explain the inner workings in this paragraph. Still, a very interesting method to prevent and treat cancer.

Over the past week this stock has received an analyst upgrade so that the mean recommendation is a 1.8 out of 5 - which puts it firmly in the BUY territory. The company is still not into positive earning territory and much depends not only on successful trials and the FDA, but with a strategic partnership for development, promotion, and distribution of the drugs. Shares have recently made a very nice bounce off the $3 mark. Although I am always a bit hesitant of pharma-stocks due to the high risk and many unknown factors - this could be a 'feel-good' stock to own that has big potential.

ALTI - The problem with certain green energies, such as wind and sun, is storing the power. You cannot simply demand a gust of air or a ray of sunshine when you need some extra power to run your windmill or solar cell which powers your food processor for that late night beet/carrot shake.

Lithium-ion batteries are good storage devices, and Altair Nano (93.76 million market cap) is a leader in this field. Their cutting edge batteries can be recharged 25x more than traditional lithium-ion batteries, and the Altair brand still holds 80% capacity. Although sales have grown over 77% in the last year, trailing 12 month sales only equal 8.2 million. Earnings are still deeply in the red - but this is a story stock with potential, right?

The University of Hawaii is installing some of these batteries and hopefully the showcasing of how the technology practically works will increase awareness. This stock has seen a large slide over the past few years and is not for the weak of heart. A recent bounce off the 50 day moving average gives an indication of where a good entry, or at least a test of support might lie.

DTLK - Cloud computing is all the rage these days and it'll be something else tomorrow. Companies who want to stay current and streamlined often need to upgrade or get a specialist who can recommend which route to go. Datalink is a 163 million market cap company that specializes in IT.

Datalink is profitable with a P/E of 17.7, and the next 5 years of growth is expected to be 20% per annum. Its worth noting that the last 4 quarters have had some extremely high positive earnings surprises, and analyst earnings forecasts have jumped almost 33% for next year. When you compare the price-to-earnings ratio against the future growth estimates, this seems like an attractive buy (PEG of 0.71 according to Yahoo). Will it grow into an empire? I don't know but for now it seems like one to watch as prices have put in a $9.00 support and it heads for a re-test (or a break-down).

Finding Your Own High-Growth Micro-Cap Stock
How can you uncover your very own micro-cap stock with high-growth potential? While big names like Google (NASDAQ:GOOG), Apple (NASDAQ:AAPL), and Baidu (NASDAQ:BIDU) might be the first that come to mind - these are massive market cap stocks that are not likely to go 10x their value - no matter what Mac-addicts might tell you. There is the issue of market saturation and the unsustainable nature of logarithmic growth.

A good place to begin is by looking at stocks under 300 million market cap. I often prefer a component of insider ownership since management should have a vested interested in share prices. I use 10 - 20% minimums, but you can use whatever you like. To have some liquidity there needs to be sufficient daily volume. How much liquidity depends on the amount you are investing. I suggest 100K at a bare-bones minimum but probably more. Next you need to decide if you want to look at stocks from all countries, or just the USA. As well, you can add an additional filter that compares quarter over quarter growth for any earnings and sales growth requirements.

Ticker Company Sector Industry Market Cap
ABIO ARCA biopharma, Inc. Healthcare Biotechnology 12.52
AGD Alpine Global Dynamic Dividend Fund Financial Closed-End Fund - Foreign 160.13
BONE Bacterin International Holdings, Inc. Healthcare Biotechnology 76.92
BSDM BSD Medical Corp. Healthcare Medical Appliances & Equipment 88.48
CBLI Cleveland BioLabs, Inc. Services Research Services 75.49
CDXS Codexis, Inc. Healthcare Biotechnology 221.96
COWN Cowen Group, Inc. Financial Investment Brokerage - National 260.3
FFN FriendFinder Networks Inc. Technology Internet Software & Services 94.26
GNOM Complete Genomics, Inc. Healthcare Biotechnology 288.53
GTXI GTX Inc. Healthcare Biotechnology 172.45
IKAN Ikanos Communications, Inc. Technology Communication Equipment 74.25
IMN Imation Corp. Technology Data Storage Devices 276.6
KV.A KV Pharmaceutical Co. Healthcare Drug Delivery 91.62
MXL MaxLinear, Inc. Technology Semiconductor - Specialized 168.49
OXGN Oxigene Inc. Healthcare Biotechnology 153.2
PATH NuPathe, Inc. Healthcare Biotechnology 74.89
ROIAK Radio One Inc. Services Broadcasting - Radio 81.93
SYMX Synthesis Energy Systems, Inc. Basic Materials Specialty Chemicals 91.42
VDSI VASCO Data Security International Inc. Technology Security Software & Services 294.81
VLNC Valence Technology Inc. Industrial Goods Industrial Electrical Equipment 171.05

Of this list you can look for a few items.

  • Stocks that currently have positive 12 month trailing earnings are COWN, MXL, ROIAK, and VDSI. FFN was expected to report positive earnings, but on August 15th the reported a loss of 55 cents. That is the high risk of these little companies, little ripples can have huge effects.
  • Another ratio to consider is how much of the share price can be tied to net asset value. A value of one implies that share prices trade at net asset value. The lower the better if all things are equal, but it often means that investors have the prices low for a reason. Also, with so many unknowns in these little stocks combined with negative earnings, the book values need to be low. Imation Corp has a price-to-book (P/B) value of 0.36, Radio One has a P/B value of 0.62, COWN at 0.57, and Synthesis Energy Systems has 0.99.
  • Also keep in mind that AGD is a closed-end fund with a dividend of 11.1%.
  • GNOM, GTXI, IKAN, ROIAK, SYMX, VDSI, and VLNC are making bounces off a support of some sort while the others seem to be in a slide for the time being.

It is quite likely that most of the stocks listed above are not suitable for many investors. The point was not to make a finalized recommendation list out of the 20 listed companies, but to show you how to filter down the myriad of stocks to a handful worth a closer second-look.

Exercising Caution When Buying
It is good to keep in mind a few particulars when digging through stocks and deciding when to buy.

  1. Companies start hitting sustainability around the time they report positive earnings. A company can give you added risk and stress if they have high debt and profitability is a long way off. This can lead to continual dilution of shares or seeking out higher debt sources - neither of which you want.
  2. As smaller retail investors typically invest in these type of companies, you may notice higher volatility and pronounced effects of events such as 52 week highs and lows or post announcement earnings drift (PEAD) when positive earnings surprises are released (or earnings that greatly exceed the same quarter last year where no analysts are covering the stock).
  3. Momentum factors are generally higher in smaller stocks. This is a phenomenon where stocks that have been winners over the past 3, 6, and 12 months generally do so over the succeeding year. Losing stocks tend to lose using the same methodology. After a few years these trends reverse. So by picking a stock that is going up over the last year, or a down stock that has struggled over the past 3 - 5 years but is finally showing positive signs of life, you will increase your chances of getting a good stock at the right time.

Buying micro-Cap stocks is a risky game to play, but when your due diligence pays off and you find a big winner, it'll be a story to tell your grandkids about.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.