Naturally, Apple (NASDAQ:AAPL) and other large caps spring to mind. (Read the Top 10 S&P Stocks of 2012 list as of Q3 for all the details.) However, the reality is that smaller companies have a heck of a lot more room to run simply by virtue of their upside potential.
After all, how much bigger can a company like Apple get? It might keep growing … but does anyone expect this stock to double? How about triple? Or better yet, race up more than 600%?
That’s the kind of performance we’ve seen in some of the hottest small-cap stocks on Wall Street this year.
I ran through the top performers of the Russell 2000 index — the most popular small-cap benchmark — to exclude the microcaps but keep focused on small- to mid-sized businesses that have seen exponential growth in the past nine months. The companies are largely biotech stocks, but also include retail and housing investments. Most importantly, the returns range from 210% to an amazing 670% returns since Jan. 1.
Interested in the list? Well take a look:
YTD Performance: +210%
Bon-Ton Stores (NASDAQ:BONT) is up three-fold year-to-date, thanks to a number of things … but profits certainly aren’t one of them.
The company still is severely pressured by the macro picture — as are many brick-and-mortar retailers, from Abercrombie & Fitch (NYSE:ANF) to J.C. Penney (NYSE:JCP), thanks to weak spending and the rise of e-commerce options like Amazon (NASDAQ:AMZN).
However, a new CEO taking over early this year sparked a rally (and a short squeeze, it seems), and a recent upgrade from KeyBanc Capital markets from hold to buy with a $15 target has helped sustain the rally.
#9: Xoma Corp
YTD Performance: +235%
Xoma Corp (NASDAQ:XOMA) is one of many biotech stocks that will make up this list of high fliers in the Russell 2000.
Xoma develops antibody-based therapeutics. It’s a beginning-phase medical company that is bleeding cash as it works toward clinical trials and (hopefully) the eventual approval of its treatments — then, the cash will start rolling in and probably be followed by a buyout offer from Big Pharma.
XOMA has soared this year on a favorable outlook for its drug gevokizumab, which was granted “orphan drug” status by the U.S. Food & Drug Administration for a condition known as uveitis. Uveitis is swelling or inflammation of the middle layer of the eye, and there aren’t a lot of treatments out there. Thus, the FDA has expedited research by this orphan drug designation, which means Xoma could be taking the fast track to market with this treatment if all goes well.
#8: Orexigen Therapeutics
YTD Performance: +255%
Orexigen Therapeutics (NASDAQ:OREX) peaked at $7.73 in July before dropping off sharply, but it has come fighting back to a roughly 255% gain year-to-date on the hopes that its obesity drugs will be well-received.
The reason isn’t anything particularly extraordinary on the OREX front, but simply a sympathy bounce thanks to enthusiasm over other obesity drugs. The FDA’s advisory panel has ruled favorably on Arena Pharmaceuticals (NASDAQ:ARNA) drug lorcaserin and Vivus (NASDAQ:VVUS) medication Qnexa, and that could pave the way for other treatments.
OREX still is bleeding cash as it works on its research, but given the obesity epidemic and the push for prevention and treatment, this area of the medical industry is generally a very good place to be.
#7: Patrick Industries
YTD Performance: +255%
Patrick Industries, Inc. (NASDAQ:PATK) is a distributor of building products and materials that are used in the mobile home and RV industry. Bullishness on housing has lifted Patrick in 2012.
As we saw with large-cap stocks, the sense of a bottom in the real estate market has lifted many builders and related companies, including D.R. Horton (NYSE:DHI), Lennar (NYSE:LEN) and PulteGroup (NYSE:PHM). All three of these picks are members of the Top 10 S&P Stocks of 2012 list as of Q3.
In its fiscal second quarter, reported recently, Patrick posted EPS of $1.22 — more than the entire earnings of fiscal 2011 and fiscal 2010 put together! And when you consider that PATK lost money in both 2009 and 2008, you can understand why investors believe in this turnaround small-cap.
YTD Performance: +325%
The biotechs keep coming! This time, it’s Pharmacyclics (NASDAQ:PCYC), a clinical-stage company focused on treatments for cancer and immune-system related diseases.
Pharmacyclics also is bleeding cash, like the other companies mentioned earlier, because it is focused on clinical trials instead of actual marketing and sales right now. But favorable outlooks for its leukemia, lymphoma and autoimmune drugs appear to be buoying the valuation of PCYC in anticipation of future sales.
The important thing to remember with all these biotechs is that they are highly speculative — and the lion’s share of gains can come quickly on one favorable FDA report. Conversely, all it takes is a bad clinical result to ruin the company, so know the risks before you dabble in biotechs.
#5: Arena Pharmaceuticals
YTD Performance: +350%
Earlier in 2012, Arena’s lorcaserin medication became the first new prescription weight-loss drug in more than a decade to win FDA final approval, tapping into a highly lucrative market.
Of course, Arena does other things, too. This clinical-stage biopharmaceutical company also is dabbling in cardiovascular, nervous system, inflammatory and metabolic disorders.
#4: Sunesis Pharmaceuticals
YTD Performance: +395%
See a trend yet? Sunesis Pharmaceuticals (NASDAQ:SNSS) is a biopharmaceutical company focused on cancer drugs, particularly leukemia.
Sunesis is a good example of a niche drug company, where a biotech company focuses on a relatively small patient pool — leukemia in all its forms is discovered in “only” 50,000 people nationwide each year … compare that to say, the 36 million with high blood pressure, and it’s naturally a smaller opportunity for Sunesis. However, with a high-cost treatment that is very effective, a biotech stock like this can really cash in by dominating a small but profitable niche.
Sunesis appears to have its act together, recording a profit in its fiscal first quarter thanks to a payment from partner Millennium Pharmaceuticals, indicating that the company is indeed figuring out a way to move past development and into the actual money-making part of the biotech life cycle.
#3: Ellie Mae
YTD Performance: +405%
Ellie Mae (NYSE:ELLI) is an electronic mortgage origination network, connecting about 55,000 real estate professionals to lenders. Obviously, this wasn’t a booming business as housing cratered, but hopes of a turnaround have meant brisk business and a very impressive improvement in Ellie Mae’s bottom line.
Consider that so far this year, the company has recorded earnings of 37 cents per share — more than the entire amount recorded in fiscal 2009 (12 cents), 2010 (6 cents) and 2011 (18 cents) combined!
As mentioned before, the Top 10 S&P Stocks of 2012 list as of Q3 included a lot of homebuilding stocks, so it’s not surprising to see a housing play in this small-cap index, too.
#2: Threshold Pharmaceuticals
YTD Performance: +490%
Yeah, yeah … more biotechs. Makes you wonder why you haven’t been investing more in the health care sector, doesn’t it?
Anyway, Threshold Pharmaceuticals (NASDAQ:THLD) has logged a stunning 490% jump so far in 2012. This is yet another company chasing a cancer cure, with focuses on blood cancers and bone marrow cancer like leukemia. These conditions have very few treatments available, and that’s why you see so many biotech companies racing to develop an effective medication. In addition to helping patients who have no alternatives, the first company to develop a blockbuster cure will also be rolling in dough as a result.
The company is not without risk, since despite great results from a February study we saw shares take a sharp leg down in September after data on another round of tests wasn’t as favorable … however, these biotechs are bound to be volatile since they live and die based on clinical results.
#1: BioDelivery Sciences
YTD Performance: +670%
Have you gotten the memo about biotech stocks yet? The highest flier in the entire Russell 2000 is BioDelivery Sciences (NASDAQ:BDSI), a specialty pharmaceutical company that is focused on — you guessed it — cancer. Other areas BDSI is pursuing treatments in include pain therapy.
But rather than dive into this stock — shocker, favorable clinical results drove the rise and the company has finally started making money instead of bleeding cash — I want to offer a cautionary tale before you go racing for this top pick.
Consider that while huge gains are possible, the losses in biotechs are equally painful.
It’s great when you catch lightning in a bottle with a development-stage biotech that figures it all out. But be aware that the flip side is a distinct possibility, and that this sector is perhaps the most volatile on Wall Street because one FDA report literally can make or break a company.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing he did not own a position in any of the stocks named here.