The Key Word Is 'Potential'

 | Apr 13, 2012 | 5:00 PM EDT
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Liquid large-caps such as Apple (AAPL) and (PCLN) have dominated the ranks of market leaders in recent months -- not unusual when a market rally is no longer young.

Of course, in any kind of market, there are smaller, newer names showing potential. However, a few of the small-caps and recent initial public offerings have struggled lately after showing some potentially good technical indicators in recent weeks.

For example, Tangoe (TNGO), a maker of telecommunications software for businesses, went public at $10 in July 2011 and rallied to a high of $20.05 on March 27. The stock has a beta of 1.1, an indication of its volatility relative to the general market. It has a market cap of just $672 million, although it has some decent liquidity, moving 630,000 shares a day.

In the early stages of a market uptrend, newer, smaller stocks like Tangoe often notch healthy price gains. However, in a downward trending market, these are exactly the names that underperform the indices. Right now, especially as day-to-day mood swings among traders have re-emerged, it's best to let a stock like Tangoe consolidate.

I like its medium- and longer-term prospects. The company has recorded good earnings and revenue growth, and it is expected to continue along those lines. Other fundamental metrics, such as its return on equity of 32%, also bode well.

Another small-cap growth favorite that's faltered lately is InvenSense (INVN), a California-based designer of motion-processing chips. The stock made its NYSE debut at $7.50 in November. After the typical post-IPO pullback, it began racing higher in January, rallying to a high of $23.35 on March 26.

Here, too, market weakness dragged down the stock. However, unlike Tangoe, which is holding above its 50-day average, InvenSense gapped below that line in heavy trade on April 4. It remains in the cellar, despite a lower-volume rally attempt in recent sessions. InvenSense is a good example of why it's not wise for long investors with a growth focus to sit through steep pullbacks like this, basing their decision on fundamentals. It's not uncommon in weak or volatile market conditions to see some of these smaller stocks etch steep corrections while their fundamentals remain strong.

InvenSense has sported triple-digit earnings growth in the past two quarters, and revenue has grown at a rate of 43% or higher in the past five. This year, income is seen more than tripling, to $0.45 a share. InvenSense has a market cap of around $1.2 billion. It trades about 2 million shares a day, on average. Downside trade has outpaced upside in recent weeks.

A mid-cap IPO leader that's also struggling is Michael Kors (KORS). The designer apparel maker and retailer launched on the NYSE at $20 in December. It barely paused for a pullback a few weeks after its debut, then sprinted to a high of $50.69 on March 9. It meandered lower in the recent general market weakness, and it's tightly hanging on to its 50-day average.

Here again is a company with outstanding fundamentals that indicate potential ahead. For investors who bought on the way up and have a cushion in the stock, they may be able to hold through this consolidation. However, new investors would be better off waiting to see if support at the 50-day is maintained. A further pullback in the general market could drag the stock down further. I like the fundamental potential and technical history on this stock, but until the broader market confirms an uptrend, I would consider Kors a risky buy.

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