Two Intriguing Small-Cap Picks

 | May 28, 2013 | 12:00 PM EDT
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Investing in the small-cap space can be a lucrative investment strategy. It takes more patience and research, however, to be successful over the long term.

Equities in this market niche are not followed as widely by analysts as are their larger brethren and there tends to much less information on the underlying companies. On the positive side, a disciplined investor can often uncover an undervalued stock before it comes to the attention of the crowd. This can lead to big returns.

Back in mid-September I highlighted two small $8 trucking stocks Swift Transportation (SWFT) and Arkansas Best (ABFS), whose earning potential in an improving economy I thought was deeply undervalued by the market. Both stocks have more than doubled since the article as investors have come to similar conclusions. Obviously, not every small-cap selection will turn in this sort of performance, but it is a good example of the bargains one can find in this space on occasion.

One thing I look for when searching for undervalued gems in the small-cap area is companies in which funds have recently taken major positions. Another clue is if there has been recent insider buying. These can be signs that pressure to improve underlying performance is in the wings or that officers in the company believe an equity is significantly undervalued.

Here are two small-cap stocks that recently popped onto my radar to look into further due to significant new stakes by funds as well as some small amount of insider buying. Coincidentally, both go for around $8.50 a share.

Resolute Energy (REN) is a $500 million market capitalization company that explores and develops oil and gas properties in Utah, Wyoming, North Dakota, and Texas. Sageview Capital recently disclosed it has taken a better than 6% position in the firm. It also mentioned in its 13D filings that it may make "suggestions" on how to improve its operations, prospects and financial strategies.

The company recently raised just over $100 million by issuing new equity. Proceeds will go to reducing debt and to help pay for a $120 million purchase late last year for some Permian Basin assets. The company has also provided guidance that production should increase better than 30% this fiscal year. An insider recently made a small purchase and the company has 80 million barrels of oil equivalent of proved reserves, 90% of which is oils and liquids. Wunderlich raised its price target to $13 a share in March, which seems achievable if the company can make strides rationalizing its production further.

Vocus (VOCS) is a small ($170 million) cloud marketing software provider that enables businesses to attract, engage, and retain customers. The company's offering include a social media software solution that helps customers run social marketing campaigns. Despite being in a hot niche, the stock lost some 30% in late April. This was after Vocus reported quarterly earnings that missed expectations on the top and the bottom line as well as offering disappointing guidance. Okumus Fund Management raised its stake in the firm to 23% of the voting shares during the sell-off. In its recent 13D filings Okumus stated "financial performance can be improved to create greater value for shareholders" and is recommending two directors to the board.

Vocus does have some things to recommend it while shareholder performance improves. It has almost 25% of its market capitalization in net cash on the balance sheet. Analysts also expect the company to grow revenues at better than a 10% compound annual growth rate over the next two fiscal years, and they have a median price target of $12.50 on the shares. In addition, an insider just bought over $200,000 in new shares. Another officer purchased almost $1 million in shares in late February.

Given its small market capitalization, recent slide and interesting product line, I would not be surprised to see Vocus becoming a bite-sized acquisition for a larger software provider even as the company has recently adopted a "stockholder rights" plan.

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