Small Size With Big Potential

By Sham Gad | October 13, 2011 AAA

As the saying goes, good things come in small packages. For investors, many of today's successful corporations started off significantly smaller in size and scale. Finding small caps with the potential of becoming big time winners is part skill and part luck. Below are a few names that offer investors some intriguing opportunities; however, as always, there can be no substitute for one's own research and analysis.

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Making a Comeback
The market turbulence of past several years has taken big businesses and turned them into small businesses, at least from a market capitalization perspective. In most instances, as in the case of many homebuilders, the shrinkage in size may be more than a temporary thing. It's doubtful that business volume will be anywhere close to the 2006-2007 levels, for homebuilders, anytime soon. On the other hand, a name like consumer goods company Helen of Troy (Nasdaq:HELE) has the opportunity to grow bigger. Shares currently trade for $26, or a market cap of $837 million. Sales have grown over the past three years from $622.7 million to over $777 million, a respectable accomplishment in this environment. Analysts expect sales to exceed $1 billion over the next couple of years. Shares currently trade at less than 9 times earnings. (For more reading, see Investment Valuation Ratios: Price/Earnings Ratio.)

Climbing Higher
Auto parts supplier Dorman Products (Nasdaq:DORM) makes and sells over 120,000 automotive replacement parts to retailers and other distribution outlets. Sales have grown from $342.3 million in 2008 to $455.7 million in 2010, and will likely eclipse $500 million in 2011. Profit growth rate has been even faster. Shares trade for $39, or a market cap of $695 million. The company is also free from short-term debt. A couple of weeks ago, AutoZone (NYSE:AZO), the nation's largest retailer, reported another strong year with net sales growing by over 9% to over $8 billion. Such strength in the parts industry bodes well for Dorman.

Building Up
Infrastructure construction company Sterling Construction (Nasdaq:STRL) looks like a sterling company from a variety of angles. The business sports a market cap of $203 million, generates nearly $500 million in sales and has over $70 million in cash on the balance sheet. Infrastructure demand continues to be a bright spot in the construction world, and it looks like Sterling knows how to make money doing it. Shares trade for 12 times earnings, but less than 7 times earnings when you strip out the cash. (For more on investing in infrastructure, see Build Your Portfolio With Infrastructure Investments.)

The Bottom Line
In investing, bigger isn't always better. Small caps often have little or no analyst coverage. Many institutional funds can't make any significant investment in smaller size companies. As a result, greater inefficiencies reside in small caps increasing the likelihood of finding significant mispricing.

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