By David Sterman
It's no secret that small-cap and micro-cap stocks really take it on the chin when investors grow skittish. A 5% or 10% drop in the broader market can lead to even deeper hits for these riskier stocks. The converse is also true: When the market is in rebound mode, these oversold stocks can post some of the most impressive rallies.
At this point, investors in a buying mood are faced with two choices: They can either focus on lower-risk blue chips that appear inexpensively valued and possess respectable upside. Or they can focus on riskier, beaten-down stocks that could rise much more sharply in an improving economy.
I've spent a considerable amount of time the last few months focusing on blue-chip bargains. Here's a look at the other end of the spectrum -- five stocks under $5 that could rise sharply in the next few years, granted the global economy dodges a bullet with the current crises.
1.Dryships (Nasdaq: DRYS)
Recent price: $2.80
The dry shipping industry, which carries dry-bulk goods on massive container ships, has been beset by weak demand and too much capacity. As a result, lease rates for these ships plunged, leading many industry players to scramble for survival.
DryShips, which traded above $100 in 2008, is now worth less than $3 a share. Yet just-released quarterly results imply that a bottom has been reached. Better-than-expected lease rates led to $318 million in revenue, ahead of the $296 million consensus forecast. Better still, the company topped the consensus profit forecast for the first time in four quarters, earning two cents more than the $0.14 prediction. Profits would have been a lot more robust if not for some bad bets on currency swaps. This stock will never revisit its past heights, simply because its share count has risen nearly 1,000% in the past four years, but a return to $5 or even $7 isn't out of the question now that industry dynamics are reversing.
2. Leapfrog Enterprises (NYSE: LF)
Recent price: $4.81
Back in January, I predicted this maker of education-oriented toys was poised for a good year.
In subsequent months, the company failed to deliver on the promise I foresaw, so its share price moved opposite the direction I had anticipated. Yet just-released quarterly results were nothing short of a blow out, and a fresh stock surge has moved it up more than 10% from where I originally recommended it. Further upside looks quite possible.
That's because Leapfrog's LeapPad, a sort of iPad for toddlers, is finally gaining serious traction (though device-specific sales weren't divulged). This fueled a 9% year-over-year gain in third quarter sales to $151 million, and earnings per share (EPS) of $0.35 were nearly 30% ahead of forecasts. Yet it's the all-important holiday season that could lead to a stock breakout. As analysts at Needham note, the $100 LeapPad's "camera and internal memory give it a strong advantage over competitors' products, as does its strong library of apps and the pedigree of the Leap Frog brand." They see shares trading up to $6.
3. Casual Male (Nasdaq: CMRG)
Recent price: $3.96
This menswear retailer, catering to the "big and tall" crowd, is a perennial member of my top low-priced stocks list. Management has done a great job of cutting costs and boosting margins, leading to a nice profit rebound. This comes at a time when consumer demand remains lousy, so any eventual rebound on consumer spending could really ignite this business model.
The numbers tell the story. Sales fell from $464 million in fiscal (January) 2008 to $394 million in fiscal 2011. Yet EPS rose from $0.09 to $0.32 during that time, thanks to tight cost controls. Results released in August portend even better days ahead. Sales rose 4% in the second quarter to $101 million compared with the same period in 2010, fueling a 17% jump in net income. EPS of $0.14 was the best quarterly showing in more than three years. Look for third-quarter results on Nov. 17 for signs that this turnaround story has real legs. I see shares trading up to $6.
4. Biolase Technology (Nasdaq: BLTI)
Recent price: $3.03
I first profiled this dental technology company in January, when shares traded at about $1.50. The stock quickly moved up to a 52-week high of about $6.85 soon thereafter. A 50% pullback from that peak leads me to again remind investors of the compelling value in this stock.
Under the tutelage of fresh management that came aboard in 2009, quarterly results keep getting stronger. Sales are expected to more than double this year to $54 million in comparison with last year, and rise another 30%-40% in 2012 as sales channels are tweaked.
This stock is no longer simply a story about dentistry. Look for Biolase to release new laser-based devices in the fields of ophthalmology, orthopedics and aesthetics in 2012. This means profit growth will be erratic during the next two years as Biolase invests in these new vertical niches. This also means that (projected) $75 million revenue base in 2012 could become a $150 million revenue base in a few years. I look for this stock to revisit the 52-week high of $6.85 during the next 12 months.
5. American Superconductor (Nasdaq: AMSC)
Recent price: $4.06
This maker of wind turbines deserves a mention, albeit short (I profiled this company in more detail here). The abrupt end of a large and profitable relationship with Chinese wind-power provider Sinovel has led to a sharp drop in the company's results. But just-released quarterly results show a 30% sequential jump in bookings as the company lands new customers. A lawsuit that seeks $1 billion in damages from Sinovel could be a game changer for the company, which is valued at just $230 million. I dont' have a precise price target yet because there are too many variables right now -- where the stock goes depends on the outcome of the lawsuit with Sinovel, backlog growth and the move back to profitability. But it's definitely worth monitoring it to see if business rebounds.
Risks to Consider: Small-cap stocks only rebound when investors grow confident that the bottom of an economic cycle is only a quarter or two away. Right now, it's too soon to tell what the U.S. economy will look like in 2012.
These five stocks represent a cross-section of industries -- transportation healthcare, clean energy, education and retail. As such, they may be best bought as a basket of stocks in order to remove company specific risk and merely play the "economic cycle" angle. One large gainer among them can help energize the whole basket, since some of these stocks can rise more than 50%.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.