5 High-Flying Small Caps: What To Expect In 2012

by: Brian Nichols

Small cap stocks are exciting, they're interesting, and they are highly debated. A small cap stock can bring you great fortunes or it can bring total loss. In this article I will be looking at 5 of last year's best small cap stocks. I will explain what caused the stock to react with such gains and finally I will look at the possibility of next year, and try to determine whether or not it will continue to rise, or if it will only fall.

Genetic Technologies (NASDAQ:GENE) is engaged in a diagnostic product business and translates genetic tests in products and services. The stock has posted a one-year gain of 361% with the majority of its gains coming after the U.S. approved the launch of its breast cancer risk test. Another round of strong gains then occurred two months later, in July, after the company announced its approved breast cancer test was being launched.

This news resulted in the stock reaching a price near $11 in less than three months, which was a one year gain of 1000%. Since then, the stock has lost nearly 70% of its value, but is still trading with a 361% gain over the last year. Therefore the question becomes whether or not this stock would make a good small-cap investment and if its gains will continue.

There are a lot of questions with this company, but then again, there are a lot of questions with most small cap companies. One of GENE's biggest questions is its patent situation because companies can't patent DNA sequences. However, a company that GENE partially owns, ImmunAid Pty, was awarded a patent for its pioneering work in the treatment of cancer. This company, along with GENE, could be on the edge of greatness with the research and already approved products that will likely bring high profits. Yet investors must be concerned of its recent halt, in which the company asked that its shares be halted while it considered capital raising ventures.

Overall, I believe that at $3.50 this stock is worth a buy, but only in a small position. Because it does operate in a large market with no real competition and is constantly reinvesting its money into research. I believe that with improved fundamentals the stock will most likely rise over the next 12 months, yet I doubt it will replicate this last year's performance.

HealthStream (NASDAQ:HSTM) provides Internet-based learning and research solutions to meet the training, information, and education needs of the healthcare industry. Its stock trades with a market cap of just under $400 million and has posted gains of 172% over the last year, and is trading near all-time highs. This stock has been trending higher since January of 2009, with gains of 800%. The catalyst to its growth has been its incredible fundamental progress; the company is continuously increasing its guidance, exceeding expectations, and maintaining a strong balance sheet.

I have learned over the last six months not to doubt this stock. Every time I write something and say that it's going to trend lower it jumps 8% to create new highs. My problem with HSTM is its valuation, which is much higher than earnings. The stock trades with a P/E of more than 60, and in this economy, stocks have shown the ability to reverse very quickly at any sign of trouble. Yet this company hasn't given any reason to believe that trouble is present and I believe it still has another year of gains before it begins to regress. Because although it's a momentum stock it still trades with relatively low volume, therefore I consider it a best kept secret, which means that its chances of immediate loss are quite low.

Flotek Industries, Inc. (NYSE:FTK) is a diversified global supplier of drilling and production related products and services. The company operates in three segments: Chemicals and Logistics, Drilling Products and Artificial Lift. The stock trades with a market cap of $400 million after a 100% gain year-over-year. The stock's gains have been a result of strong performance from each of its three segments and large growth year-over-year. During the company's most recent quarter it increased revenue by 87.7% year-over-year and posted $17.92 million in revenue compared to a loss of $1.16 million in 2010. Each of the company's segments has shown incredible growth and is driving the company to higher earnings.

I believe that FTK could be one of the better small-cap stocks of the next year. The recent pullback in August negatively affected this stock as it lost nearly 50% of its value in the months of August and September. Yet since October the stock has recovered to post a gain of more than 60% and continues to trend higher. Before the selloff in August the stock was trending higher with better earnings and I believe it will continue its trend with fundamentals that continue to improve. Yahoo Finance has a one year target of $14 for FTK, however, because of its strong earnings and its recent history of exceeding expectations I believe the stock could easily surpass $17 and possibly reach $20 over the next year, as it posts its first full year of profit since 2008.

Majesco Entertainment Company (COOL) is a provider of video game products primarily for the family oriented, mass-market consumer. The stock has a market cap of $110 million and has posted a gain of 300% over the last year. The strong gains have been a result of its best selling game Zumba, and its newfound presence on Facebook with Parking Wars. The company has posted strong earnings including a 62% increase in revenue year-over-year during its last quarter and three consecutive quarters of net income.

I have owned a small position in this company for nearly a year, and it's been one of the most volatile and frustrating stocks that I own. However, I am yet to sell because I believe the company's potential is yet to be reached. And I believe that 2012 will be much larger than 2011 because of its new games, that include Zumba 2 and Parking Wars 2. In addition, the stock only trades at 12x earnings which is relatively low for a small-cap stock growing at COOL's level. And since the company increases its full-year guidance on a quarterly basis I believe its earnings will continue to improve. The stock has a $4.42 one year target, yet I believe that because of the release of Zumba 2 and its high expectations that the stock will trade high above earnings and that a $6 target is reasonable.

Rediff.com (NASDAQ:REDF) along with its subsidiaries, is engaged in business of providing online Internet based services, focusing on India and the global Indian community. REDF trades with a market cap of $437 million after gains of 150% over the last year. The company's site is among the first in India to offer such a wide range of services which include: web search, images, videos, air fare, jobs, deals, sports, etc. The site doesn't replicate any successful company in the United States, which is a much different strategy than what several of the large Chinese internet based companies have attempted. Rediff.com is unique and offers a wide range of services to a country that is growing very fast in internet usage. I believe that India's fast growing internet usage has created optimism among investors that this stock will return high profits in the near future.

I'm quite bearish on this company's future because although it's creating more revenue it's also posting higher loss, which is lowering its profit margins. The company's profit margin is nearly negative 50% and at this point I don't see how it could improve at a level that would result in profitability. Most of its gains have been the result of its potential, and l I don't believe the company's shown me enough to where I'm confident that it will grow. Therefore if I were an investor that's owned this stock for the last year I would sell and take profits.

I consider any company with a market cap under $500 million to be a small cap stock, because at this size a stock is still fragile, finding an identity, and could go either way. It's very possible that one of these stocks could become Questcor Pharmaceuticals (QCOR), which has posted consistent gains since 2007. If you would have purchased $5,000 of shares in QCOR during August of 2007 your return would now be over $600,000. This level of return is what attracts investors to small-cap stocks, however you never know when its the next Travelzoo (NASDAQ:TZOO), which posted unbelievable gains in one year only to fall by 70%. The key is to find a company that's growing with a great product/service in a high demand industry. I believe the gains for each of these stocks over the last year have been well deserved, but the question is what will happen over the next few years: Will it become QCOR or TZOO?

Disclosure: I am long COOL.

Additional disclosure: As with any investment, due diligence is required. The opinions in this article are not intended to be used to make a particular investment or follow a particular strategy.