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Small-cap stocks are often cited as good investments due to their low valuations and potential to grow into large-cap stocks, though they can be risky, especially as many small caps do not have the same resources to survive during long-term declines in the economic cycle. There is no specific definition of what constitutes a small-cap stock but it is generally considered to be a stock with a market cap of around $200 million to $2 billion. They make up around 17.6% of all listed U.S. stocks, compared with 7.4% for mid-cap stocks and 3.5% for large-cap stocks, accordingly providing a diverse range of investment opportunities. In fact some analysts are quite bullish on small-cap stocks at the moment and believe that “the bar has been set too low”, with Wall Street only expecting the small-cap sector as a whole to experience earnings growth of 4.6%. This optimistic view has been formed on the basis that the U.S. economy is performing better than expected and the expected earnings will be exceeded. For these reasons I have sought out small-cap stocks that I believe have the potential to deliver solid stockholder returns in 2012 and applied my unique fundamental analysis to determine those worthy of further investigation and analysis. I have found two Sohu.com (NASDAQ:SOHU) and First Majestic Silver Corp (NYSE:AG), which I consider to be firm candidates for further investigation and three Petroquest Energy Inc. (NYSE:PQ), Voyager Oil & Gas Inc (VOG) and Tenneco Inc (NYSE:TEN) that I believe are not. As always use my analysis as a starting point for conducting your own due diligence prior to investing.

Sohu.com Inc.

Sohu is an online search engine based in China that is involved in brand advertising, online gaming, sponsored search, and wireless businesses in China. It has a market cap of $2 billion and is trading at around $52, having dropped 17% value in since the start of 2011. It has a 52-week trading range of $46.35 to $109.37.

Despite the sluggish economic environment Sohu saw a 17% rise in third-quarter 2011 earnings to $233 million, and for the same period net income rose by 6% to $46.8 million. However, for the same period Sohu’s balance sheet weakened, with cash and cash equivalents falling 1.5% to $707 million and long-term debt rising a massive 51% to $2.6 million.

Sohu compares well to most of its competitors, except its key Chinese competitor Baidu (NASDAQ:BIDU). Its quarterly revenue growth of 42% is the twelfth highest in its industry and is higher than Yahoo’s (NASDAQ:YHOO) -24% and Google’s (NASDAQ:GOOG) 33%, but is lower than Baidu’s 94%. Its return on equity of 17% is the seventh highest in its industry and higher than Yahoo’s 8.5% but lower than Google’s 19.5% and Baidu’s 58%. Sohu also has the seventh highest profit margin for its industry of 20%, but this is lower than Google’s 28%, Yahoo’s 24% and Baidu’s 45%.

Analysts have been quite bullish on Sohu as it has a mean price target of $81.46 and is currently trading at a 36% discount to that target. This indicates that at current prices Sohu represents a solid investment opportunity. However, prior to forming a final view it is necessary to see whether the company’s fundamentals support this.

Sohu’s PEG of 0.61, profit margin of 20% and conservative debt-to-equity ratio of 0.60 indicates that the company is well positioned to capitalize on future growth opportunities as the economy improves. In addition, the company appears to be unfairly discounted by the market at current prices as it has an earnings yield of 8%, which is more than triple the current yield on 10-year Treasuries.

For these reasons I believe that at current prices Sohu has been unfairly discounted by the market and represents a solid investment opportunity that can only rise in value as the economy improves. Accordingly, Sohu is certainly worthy of further investigation and analysis.

Petroquest Energy Inc.

Petroquest is an independent oil and gas company that engages in the acquisition, exploration, development, and operation of oil and gas properties in Oklahoma, Arkansas, Wyoming, and Texas. The company has estimated reserves of 1,623 thousand barrels of oil, 8,373 million cubic feet of natural gas liquids and 174,566 million cubic feet of natural gas. It has a market cap of $441 million and a 52-week trading range of $4.72 to $9.75. Since the start of 2011 it has dropped in value by 3% to now be trading at $7 with a price-to-earnings ratio of 94.

Petroquest’s earnings are predominantly dependent upon the demand for energy and the prices of natural gas and oil. For the third quarter 2011 PetroQuest reported a 7% drop in earnings to $39 million, yet for the same period net income rose by a massive 149,800% to $5 million, from second-quarter net income of -$1.8 million. In the third quarter 2011 PetroQuest reported a weaker balance sheet with cash and cash equivalents dropping by a massive 56% to $22 million, although long-term debt remained steady at $150 million.

Petroquest’s performance with regard to its competitors is mixed. Its quarterly revenue growth of -16% is lower than both ATP Oil & Gas’ (ATPG) 67% and Petroleum Development’s (PETD) 67%. However, its return on equity of 2.2% is greater than ATP Oil & Gas’ -759%, which is one name we highlighted that could do well if oil hit $150 per barrel, and Petroleum Development’s 0.60%. In addition, analysts have been quite bullish on PetroQuest establishing a mean price target of $10.03. It is currently trading at a 30% discount to that target, indicating that at current prices PetroQuest represents a good investment opportunity. However, prior to finalizing this view it is necessary to see whether the company’s fundamentals support this.

Petroquest’s PEG ratio of 1.56, forward price-to-earnings ratio of 17 and a profit margin of 6% do not bode well for strong future earnings growth and indicate that at current prices the company is moderately overvalued. In addition its earnings yield of 1%, which is less than half of the yield of 10-year Treasuries, indicates that the stock is overvalued. All of which correlate with its highly aggressive trailing price-to-earnings ratio of 94. For these reasons I do not agree with the analysts mean price and I believe that PetroQuest is currently overvalued and is not worthy of further consideration or analysis.

Voyager Oil & Gas Inc.

Voyager Oil is involved in the exploration and production of oil and gas in the United States, being primarily focused on the oil shale resource prospects in Montana, North Dakota, Colorado, and Wyoming. It supplies energy and fuel for industrial, commercial, and individual consumers. It has a market cap of $150 million and a 52-week trading range of $8.53 to $18.83. Since the start of 2011 it has dropped by 52% in value to be currently trading at around $3.

For the third quarter 2011, Voyager Oil reported a massive 72% increase in earnings to $2.9 million and in the same period net income also rose by a massive 112% to $56,000. However, the company reported a weaker balance sheet in this period with cash and cash equivalents dropping by 30% to $22 million, although long-term debt remained unchanged at nil.

When compared with competitors Voyager Oil is performing quite strongly on earnings growth but is lagging in return on equity. Its quarterly-revenue growth of 983% is the highest in the oil and gas drilling and exploration industry, being substantially higher than Petrobras’ (NYSE:PZE) 26% and Statoil’s (NYSE:STO) 48%. Yet its return on equity of -6% is amongst the lowest in it is industry and substantially less than Petrobras’ 16% and Statoil’s 27%.

Analysts have also been quite bullish on Voyager Oil with a mean price target of $4.65 being established. It is currently trading at a 35% discount to that target, indicating that at current prices Voyager Oil represents a solid investment opportunity. However, prior to forming a final view it is necessary to see whether the company’s fundamentals support this.

Voyager Oil has a PEG ratio of -7.69, which when coupled with its return on equity of -6% does not bode well for future net income growth. It also has an earnings yield of -2.97%, which is substantially lower than current yield for 10-year Treasuries, which I believe indicates that at current prices the stock is overvalued. Therefore, despite its strong third-quarter earnings and net income growth I do not believe that Voyager Oil is worthy of further consideration at current trading prices.

Tenneco Inc

Tenneco designs, manufactures and sells emission control and ride control products and systems for commercial and specialty vehicle applications. The company sells its products principally to original equipment manufacturers and replacement markets worldwide. It is the eleventh largest company in the auto parts industry with a market cap of $2 billion. Tenneco has a 52-week trading range of $22.47 to $46.81 and since the start of 2011 has fallen in value by 26% to be currently trading at around $31, with a price-to-earnings ratio of 18.

Tenneco’s third-quarter earnings for 2011 dropped by 6% to $1.8 billion and for the same period net income dropped by a massive 40% to $30 million. However, in the third quarter its balance sheet strengthened with cash and cash equivalents rising by 1% to $163 million and long-term debt remained steady at around $1.2 billion.

When compared with its competitors Tenneco stacks up well, with quarterly revenue growth of 15%, which is higher than TRW Automotive’s (NYSE:TRW) 14% and Federal-Moguls’ (NASDAQ:FDML) 12%. Its return on equity of 112% is the second highest in its industry and is higher than TRW Automotive’s 37% and Federal-Mogul’s 13%.

Analysts have been quite bullish on Tenneco as it has a mean price target of $44.60 and it is currently trading at a 30% discount to that target. All of which on face value indicates at current prices Tenneco represents a solid investment opportunity, but prior to forming a final view it is necessary to see whether the company’s fundamentals support this.

The company is heavily leveraged with an extremely high debt-to-equity ratio of 10.87, which I do not believe is a good indicator for a company that only has a return on equity of 15% and a profit margin of 1.7%. However, its PEG ratio of 0.73 bodes well for future earnings growth.

I also believe that these poor growth prospects have been factored into the current trading price by the market as the company has an earnings yield of 5%, which is only slightly higher than the current risk-free yield of 10-year treasury bonds. This indicates that at current trading prices the stock is overvalued. When this is considered in conjunction with the substantial 40% drop in third-quarter net income I do not believe that the company represents a buying opportunity at this time and is not worthy of further research and investigation.

First Majestic Silver Corp

First Majestic is a silver miner and explorer with a focus on Mexico. It is the second-largest silver miner in its industry by its market cap of $2 billion. It has a 52-week trading range of $10.32 to $26.88, and since the start of 2011 has risen 20% in value, currently trading at around $19, with a price-to-earnings ratio of 21.

First Majestic reported that third-quarter 2011 earnings dropped by 9% to $60 million and net income dropped by 8% to $27 million. Its balance sheet also weakened during this period, because despite cash and cash equivalents rising 9% to $119.5 million, long-term debt rose by a massive 53% to $10 million.

First Majestic stacks up well against its competitors as its quarterly revenue growth of 89% is the fifth highest in its industry and greater than Pan American Silver’s (NASDAQ:PAAS) 37%, but lower than Silver Wheaton’s (NYSE:SLW) 99.5%. Its return on equity of 35% is the second highest in the industry and greater than Silver Wheaton’s 23% and Pan American Silver’s 20%.

Analysts have also been quite bullish on First Majestic, which has a mean price target of $23.64, which represents a 20% premium to its current stock price. This indicates that at current prices First Majestic represents a good investment opportunity, but prior to forming a final view it is necessary to see whether the company’s fundamentals support this.

First Majestic has a solid profit margin of 45%, which is the fourth highest in its industry, and in conjunction with its solid return on equity of 35% indicates that it is able to cost effectively translate earnings into net income. The company also has a PEG ratio of 0.16 and a debt-to-equity ratio of 0.03, both of which bode well for future earnings and net income growth.

In addition, the outlook for silver is quite bullish despite it being 3% down since the start of 2011 and currently trading at around $30 an ounce, which is far below its 2011 peak of almost $50 per ounce. Many analysts are quite upbeat on the prospects for silver with some believing that its price could go as high as between $100 and $200 an ounce in the next 18 months. This of course bodes well for the earnings of silver miners such as First Majestic and when this is considered in conjunction with its solid profit margin of 45% indicates that company is well positioned to translate any increase in the silver price into net income growth.

Finally with an earnings yield of 1.9%, the stock appears to be overvalued by the market at current prices when compared with the current yield of 10-year Treasuries. However, its forward price-to-earnings ratio of 10.5 does make it look cheap when future earnings are considered. This is a particularly difficult stock to pick based upon its current price-to-earnings ratio and earnings yield. However with strong profitability indicators combined with the particularly bullish outlook on the silver price, I believe that it is a candidate worthy of further investigation and analysis.

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

Source: 2 Small-Cap Stocks To Consider, 3 To Avoid