3 Small-Cap Gems to Winterize Your Portfolio

by Louis Navellier | October 23, 2013 9:03 am

Winter is coming. As a fund manager, I could hardly be more excited about this. Later this week I’ll dig into all the reasons why we are entering what is truly the happiest time of year for the stock market (especially small- and mid-caps), but I want to get this bulletin out immediately. That’s because today I’m going to introduce what I consider to be three of the best small- and mid-cap stocks on the market right now.

What To Watch Out For

But first, a word of caution. I will be the first to admit that there is a lot of “froth” in this market. A textbook case of this is Tesla Motors (TSLA[1]), since the company is grossly overvalued relative to its sales and underlying earnings.

Just take a look at its Portfolio Grader rankings[2]. You’ll see that while TSLA is an A-rated stock right now, that’s only because of its Quantitative Grade, which indicates the current level of institutional buying pressure. What happened was when Tesla got added to the NASDAQ 100 to replace Oracle (ORCL[3]), the company benefitted from increased buying pressure from managers looking to replicate the index’s performance. This help explains why the company now has a market capitalization in excess of $20 billion, which is over 10 times its annual sales pace and well over 400 times its forecasted earnings!

While I always like to see a healthy Quantitative Grade, in the small- and mid-cap arena it’s essential that a stock is also backed up by healthy fundamentals. That’s where TLSA falls short, with a C-rated Fundamental Grade. Of the eight fundamental metrics I graded this stock on, it scored well on just two metrics—sales growth and earnings momentum. Meanwhile, it squeaked by with Cs on four metrics (including operating margin and earnings growth), and it outright failed on cash flow and return on equity. So while TSLA is an A today, slight changes in buying pressure could send this stock down to a C-rating (or lower) easily.

The case with Tesla shows that there are some valuation problems brewing as multi-billion dollar Wall Street ETF machines continue to buy stocks, regardless of valuations. But I want to stress that this “froth” does not exist for all small- and mid-cap stocks. In fact, there are some unprecedented buying opportunities to be had before the market realizes where the quality truly lies.

Speaking of which, I have my eye on these three stocks:

LGF Is Catching Fire

Lions Gate Entertainment (LGF[4]) is an up-and-coming independent filmmaker that is rapidly catching up to Hollywood’s biggest studios. The company has a number of films coming out before year-end, including Ender’s Game, based on the first book of the popular young adult series that could turn into a blockbuster franchise if it is well received.

But the real buzz surrounding Lions Gate is the November 22 release of Catching Fire, the second installment of The Hunger Games film series. Projections already expect the movie to open to north of $160 million during the first three days domestically, putting the film among the top-five biggest openings of all time and outpacing the $152 million domestic open of the first Hunger Games movie. All this is solid news for Lions Gate, so analysts have revised next quarter’s earnings estimate up 9% to $0.49 per share in the past month. This represents nearly 82% bottom-line growth.

While LGF shares pulled back today, I consider this an opportunity to add this A-rated stock[5].

Winning Winnebago

My second mid-cap recommendation is Winnebago Industries (WGO[6]), one of the biggest names in the recreational vehicle industry. In addition to its namesake motor homes, Winnebago makes panel-type vans with sleeping, kitchen, and/or toilet facilities under the Era brand name. Finally, Winnebago also manufactures travel trailers and fifth wheel towable products under the Winnebago and SunnyBrook brand names.

Big ticket items like RVs were shunned during the weakness in the economy over the last several years, but more recently Winnebago has returned to profits and its stock price is rebounding, most recently by its big earnings beat. The company reported a much better-than-expected profit of 38 cents per share, more than doubling from the 14 cents adjusted earnings per share year-on-year, and sales rose 32% to $214.2 million. Analysts were expecting 27 cents earnings per share on revenues of $206.1 million, so Winnebago posted a 40.7% earnings surprise and a 3.9% sales surprise.

The company’s backlog continues to grow due to rebounding demand from both dealers and consumers, which bodes well for Winnebago going forward. So I have little doubt that WGO will maintain its A-rating[7] as we head into the seasonally-strong time of year.

Gotta Have Haverty’s

My final recommendation is a direct beneficiary of the housing recovery. Home sales are on the rebound, and that means that homebuyers will be looking for new furniture and decorations to outfit their new lodging. That’s great news for companies like Haverty Furniture (HVT[8]), which is a full-service home furnishings retailer.

125 years ago, a single Haverty’s opened in downtown Atlanta and distinguished itself through its quality furniture and quick delivery of goods. Since then, the company has expanded to 100 stores across 17 states, and employs over 3,000 people nationwide. Today, Haverty’s sells middle-to upper-range furniture and offers furniture to outfit every room in the house, including home offices and media rooms.

While this is a B-rated stock at the moment, it has remained squarely at a buy rating for over the past year—something that you don’t see all that often with mid-cap stocks. And I believe that its upcoming earnings announcement (scheduled for October 31) could be just the thing to push HVT shares back up to an A-rated buy. Currently, analysts are calling for 7.9% annual sales growth and a whopping 135.7% earnings growth. Better yet, the analyst community has revised this quarter’s earnings estimate up nearly 14%…in just the past month! This suggests that we’ll see another double-digit earnings surprise from Haverty’s, just as we have for the past several quarters running.

So you see, despite some of the valuation problems the market is having right now, with the right tools at your fingertips, you can avoid these pitfalls and zero in on the profit opportunities. As always, our best defense is a strong offense of fundamentally superior stocks with persistent institutional buying pressure. So run all of your positions through Portfolio Grader, consider adding the three stocks I highlighted above, and enjoy the ride, because I am expecting a big flight to quality and a strong finish to the year.

Endnotes:
  1. TSLA: http://studio-5.financialcontent.com/investplace/quote?Symbol=TSLA
  2. Just take a look at its Portfolio Grader rankings: http://navelliergrowth.investorplace.com/portfolio-grader/stock-report.html?q=tsla
  3. ORCL: http://studio-5.financialcontent.com/investplace/quote?Symbol=ORCL
  4. LGF: http://studio-5.financialcontent.com/investplace/quote?Symbol=LGF
  5. this A-rated stock: http://navelliergrowth.investorplace.com/portfolio-grader/stock-report.html?t=LGF
  6. WGO: http://studio-5.financialcontent.com/investplace/quote?Symbol=WGO
  7. its A-rating: http://navelliergrowth.investorplace.com/portfolio-grader/stock-report.html?q=wgo
  8. HVT: http://studio-5.financialcontent.com/investplace/quote?Symbol=HVT

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