by Jeff Reeves | June 17, 2013 12:10 pm
Based on the recent triple-digit moves in the Dow Jones Industrial Average, volatility could heat up this summer on the stock market. But investors shouldn’t consider this as a sign that they should throw in the towel — on the contrary, buying some great picks on a pullback could be one of the best moves you can make in the next few months.
And remember, volatility is only bad if you’re holding on to investments caught in a downdraft. As we’ve seen time and time again, small and agile stocks can manage to find big opportunities in a narrow market based on innovative products or shrewd leadership.
Take electric vehicle manufacturer Tesla (TSLA), which has seen its stock soar 200% this year on bright headlines including its first quarterly profit; full, early repayment of a government loan; and continued demand for its iconic Model S sedan.
I wouldn’t buy Tesla now, of course, with shares being so frothy. But there are other small companies poised for a breakout … if you know where to look.
Here are five such small-caps that are red-hot, and could generate big-time profit for investors who buy them on a dip:
Exco Resources (XCO) is one of many oil and gas small-caps that seem attractive to me amid a soft patch for the energy sector. While shares haven’t been impressive for the past few years, recent strength and the hopes of a bright 2014 make these energy sector plays attractive as longer-term investments.
Exco is an onshore oil and natural gas play focused mainly on shale operations. That means its fossil fuels are a little more costly to extract, and that profitability depends on a high price point for natural gas and crude.
Obviously, with weak commodity prices and only modest inflation in the past few years, XCO stock hasn’t been all that grand. The company reported a steep loss in fiscal 2012 as a result. But don’t let the loss scare you, because some of the shortfalls have been self-imposed and are ultimately good for the long run. Consider that in fiscal 2012 EXCO reduced drilling rigs from 24 to just 5, slashing capital expenses by 48% — laying off more than 60% of its contractors and roughly one in six full-time employees. The restructuring hit the company hard but has put it on track again now that it has “right-sized.”
Furthermore, long-term debt has actually declined from $1.9 billion a year ago to $1.3 billion in the company’s latest earnings report, thanks to private limited partnership with Phil Falcone’s iconic Harbinger Group.
So don’t fret that this company is going under, what with lower debt and a big hedge fund buy-in.
The timing may be perfect to stake out a claim in Exco stock this summer on a pullback now that it has given up 8% in about a week on little news (other than simply the payment of its dividend). Even after the pullback, shares are up more than 12% year-to-date.
With higher margins thanks to reduced cost and agile operations that are prepped to ramp up whenever the recovery begins in earnest, this is a great cyclical energy play. There is risk, of course, should energy prices remain soft. But Exco hedges actively against declines — don’t feel like a significant move down in nat gas will ruin this pick.
EZChip Semiconductor (EZCH) is a “fabless” semiconductor company, meaning it makes the design for chips and markets them but does not fabricate the actual hardware. Its gadgets are used in network processors, routers and other high-speed Internet gear — all crucial components for businesses as well as consumers in this data-hungry age.
Semiconductors have been out of favor with many investors thanks to the threat of a “post-PC age,” but remember that all those tablets and smartphones still need connectivity to the Internet. Regardless of whether you’re on a laptop or an iPad you’ll need a network, and network devices are where EZChip makes a lot of its money.
The company has been also suffered because of a transitional 2012, moving over from Juniper (JNPR) as its largest partner to Cisco (CSCO). To wit, JNPR revenue was down 39% in fiscal 2012 while CSCO revenue increased by roughly the same amount. Cisco now accounts for 43% of total EZChip sales.
Fiscal 2012 earnings for EZCH were nearly double 2011 numbers, though admittedly revenue was soft and bigger margins from Cisco helped drive those profits. Going forward, the question is how EZChip will grow now that it has basically switched from one major networking partner to another.
I remain convinced that EZCH can get a bigger piece of the pie simply by virtue of the pie getting bigger, thanks to data-hungry consumers and businesses. Shares are down 14% year-to-date in 2013 but have shown significant strength since May 1 even as the rest of the market has stalled out.
If you’re not afraid to swim with sharks, consider the volatile Mako Surgical (MAKO) as a speculative medical device play.
The company’s gut-wrenching fall from above $40 in early 2012 to just $12 or so now is fairly well known — and considering the fall from grace came as MAKO was picked by Motley Fool founder David Gardner as one of our Best Stocks for 2012… well, readers should be fully aware of the risks and how quickly this company’s fortunes can go south.
But despite a brutal quarterly earnings report last year that prompted a one-day drop of almost 40%, and despite a current lack of profitability, there is speculative potential here for Mako. The company makes expensive robotic surgery equipment that can reduce the risk of complications for patients and reduce the length of stay at a facility — a win-win for hospitals. The potential in this kind of innovative medical device is evident in Intuitive Surgical (ISRG), the $20 billion robotic surgery company behind the DaVinci system that has taken hospitals by storm. ISRG stock is up over 2,800% in the last 10 years.
Clearly, you have to be patient … and you have to hope that the capital spending environment improves at hospitals. After all, Mako gear doesn’t come cheap, and cash-strapped hospitals reeling under Obamacare paperwork don’t have the time or inclination to just throw money at gadgets for the OR.
Then, of course, there are the recent concerns about whether robotic surgeries are actually more cost-effective in some cases.
Investors should fully understand, too, that one FDA complaint or regulatory overhaul could cause MAKO to dry up in a hurry. And with operations failing to turn a profit right now, the status quo is not enough to make this play a winner.
But the brutal selloff of the past year coupled with the demographic shift that will send more Baby Boomers to hospitals in the next few years could stack up big-time in favor of MAKO. Healthcare is a recession-proof sector with big growth ahead, and an innovator like Mako Surgical could clean up if the chips fall right.
Many investors have never heard of Virginia-based Hooker Furniture (HOFT), which has made furniture since 1924. The goods are middle-market to premium in price point, sold under the Hooker, Envision and Opus brands for use in both homes and offices.
But being under the radar is an asset for Hooker stock, since it’s fundamentals are definitely on the way up. In April, the company reported strong fiscal 2013 results (yes, its FY2013 just ended … don’t ask why) including higher sales and net income that rose 71% compared to fiscal 2012. HOFT also is forecasting its highest earnings and sales in the current fiscal year since the great recession.
But Hooker Furniture stock has lagged the market, up only 7% in 2013 thanks to a huge selloff last week on no news. Why? Well, because this pick is a low-volume issue that trades only 20,000 to 30,000 shares daily. Even a modest order could seriously affect pricing … and it appears sellers dominated the market and skewed pricing for the past two weeks.
Always use a limit order to protect yourself in a thinly traded pick like this, but consider a bargain buy into Hooker while it’s down 15% from highs set in late May. Even if all this stock does is snap back, it will deliver good results. The furniture industry is picking up momentum as the housing market mends, so there is continued chance for upside beyond the already-improving fundamentals.
The company has no debt and $26 million in cash, which is impressive for a company with just a $160 million market cap. Throw in a 2.5% dividend, and Hooker looks mighty hot.
BlackRock Kelso Capital Corp. (BKCC) is a business development company, or BDC, which generates revenue from investments in and loans to midsized companies. As that capital generates returns, BlackRock Kelso shares generate big dividends.
Of course, that means BKCC lives and dies by its underling investments. You can look into their full list of investments here for more detail, but consider that hedge funds including Legg Mason Capital Management and Citadel Investment Group have recently gotten bullish on the stock — these Wall Street firms are confident about the portfolio. Also note that, broadly speaking, BlackRock is diversified across technology, materials, manufacturing and services, which is a plus.
Obviously an economic downturn would take a bite out of many underlying investments in the BlackRock Kelso portfolio. And it may be a double whammy, since dividends could suffer from underperformance in the underlying investments, too. For instance, distributions went from 43 cents a quarter at the end of 2008 to just 16 cents in 2009 thanks to the downturn.
This is a real risk, but it swings both ways — and in good times, BlackRock Kelso really puts the pedal down. The current yield of over 10% is calculated from 26 cents paid quarterly — yet BlackRock Kelso paid 32 cents a share as recently as 2010. If the economy turns a corner and more midsized companies look to expand, BlackRock Kelso will benefit handsomely.
The company trades at book value and has a decent portfolio of investments that should keep it reasonably stable in 2013 — and hopefully a big income driver for your portfolio going forward.
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.
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