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Each month I search for small cap stocks priced reasonably based on price to earnings growth (PEG) and that have a recent history of positive earnings surprises. I use stockscreen123 as the tool for this particular screen.

The basic premise of the list is that stocks with a history of earnings surprises have the strong probability of positive earnings surprises in the future. If the stocks are already trading at favorable valuations, then continued earnings surprises could mean that the stocks below are undervalued.

Last month's list performed very well, up 5.21% for one month versus 1.64% for SPY over the same period. The list tends to be high beta and could be more volatile than the overall market. However, it is not a comprehensive portfolio but rather a starting point for further research and an attempt to uncover some "hidden" gems.

Using the identical parameters I screen each month, the strategy has performed well historically. The 5 year and 10 year performance are charted below. The screen results exclude commissions and taxes. It also limits positions sizes to 10%, in months when less than 10 stocks qualify:

click to enlarge

Datalink (DTLK) remains attractively priced as I highlighted last month. Resistance remains around $11, with the stock closing at $10.21 Thursday.

GSI Group Inc. (GSIG) designs, develops, manufactures, and sells precision motion control devices and associated precision technologies, photonics-based solutions, and semiconductor systems. It has broken the trading channel between $10-$14 it had been trading in since late 2010 and is down over 10% in a month. However, the company trades at a forward P/E of 8.38 and price to sales of .82. The company announced second quarter earnings in August, with revenue of $101.4 million, an increase of 18% over the same period a year ago. Earnings per share for the quarter were $.30 versus a loss of $(.32) a year ago and Adjusted EBITDA was $19.4 million. The company has cash and cash equivalents of $74 million and $34.1 million in net debt. The company maintained annual guidance of $375-$385 million in revenue and Adjusted EBITDA of $68 million to $73 million.

According to AlphaClone, institutional holdings have increased for GSIG for the quarter ended 6/30/11. Royce & Associates is currently the largest institutional holder with over 1.5 million shares. Ten funds bought into the stock for the quarter, zero sold out, and 17 increased their position while 2 decreased their position during the quarter.

Chart courtesy of Finviz:

Ticker Name Rank MktCap ProjPECurFY PEGLT
LABL Multi-Color Corporation 97.49 351.49 11.54 0.77
LAD Lithia Motors, Inc. 96.83 445.46 9.17 0.35
SUSS Susser Holdings Corporation 96.29 399.22 10.98 0.95
CRD.B Crawford & Company 96.11 286.29 8.47 0.56
DTLK Datalink Corporation 95.08 178.82 13.97 0.7
GSIG GSI Group Inc. [USA] 92.35 282.89 8.95 0.72
EXLS ExlService Holdings, Inc. 81.42 684.74 17.61 0.95
CBM Cambrex Corporation 80.05 153.05 10.83 0.89
SIMO Silicon Motion Technology Corp. [ADR] 74 387.35 12.41 0.62

Disclaimer/Disclosure: No current positions in stocks mentioned. Please note that Scott's Investments is not a financial adviser. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of Scott's Investments.

Source: 9 Small Caps With Positive Earnings Trends