Small-Cap Gems Among Debt Disarray

 | Oct 14, 2013 | 10:00 AM EDT
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Most of the market's focus over the last few weeks has been centered on the daily activities happening in Washington with the debt limit and budget talks.

Last week the market rallied strongly towards the end of the week on promising signs that the two sides were meeting to work out a solution to this self-manufactured crisis. It appears this trading week will begin with a pullback as talks have hit a few snags.

I am hopeful both of the contentious issues get pushed to the sidelines in the coming weeks as both sides work to some sort of compromise. Dealing with a "Risk On"/"Risk Off" market on an almost daily basis is not what long-term investors prefer to deal with. I look forward to the day we can concentrate on more important things like earnings, revenue growth and a rebounding economy.

I still have numerous concerns, however, about the overall market outside politics. This has been the weakest postwar recovery on record with tepid economic and job growth. There is unlikely to be any significant changes to either the fiscal or monetary policies that have driven this disappointing growth in the near future. It is hard to be optimistic that the economy will accelerate over the coming year or two.

The Federal Reserve will have to start to "taper" eventually, probably in the first half of 2014. In addition, S&P profit margins are at all-time highs as companies have done an impressive job in squeezing every last drop of earnings off smallish revenue gains. All this does not bode well for either solid revenue or earnings growth in 2014 for the overall market.

That leaves me believing it is going to be stock picker's market for the foreseeable future. To be successful, an investor has to find stocks or sectors that should be able to produce solid earnings and revenue growth that are selling at reasonable valuations. I am finding a good portion of these gems in the small-cap arena at the moment.

Smaller caps also have less exposure to overseas markets and demand and generally face a less burdensome regulatory environment as well. Here are a couple of quick profiles on a couple of smaller stocks that should have solid growth ahead as we navigate this political poisoned environment.

Abraxas Petroleum (AXAS) is a small exploration and production concern with acreage in most of the core shale producing ranges in the United States. The company has an enterprise value of approximately $400 million. Production is increasing at an impressive rate and Abraxas is tracking towards a 40% revenue increase this fiscal year. Analysts believe at least another 30% increase is in store for FY2014.

Earnings are outpacing revenue growth. After breaking even in FY2012, the stock is poised to produce approximately 15 cents a share in earnings this fiscal year. The consensus estimate calls for earnings to double in FY2014. Despite this growth, the stock sells for just 10x forward earnings. The company sports a solid balance sheet and insiders have been net buyers over the last few months as well.

InvenSense (INVN) delivers motion interface solutions based on its multi-axis gyroscope technology that target smartphones and tablets. Both earnings and revenue are moving up nicely this year. Revenue looks like it will post a 30% gain this fiscal year with earnings tracking to a slightly bigger increase year over year.

Consensus earnings for the next fiscal year have moved up significantly over the past few months as the company had some design wins within the new iPhones that were just launched. The company has a strong balance sheet with over 10% of its market capitalization accounted for via net cash on the books.

The stock has had a strong run recently and sells for just over 22x forward earnings. However, I would not hesitate to add to this position if we get some sort or politically-triggered decline over the next week or so.

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