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15 Small Company Stocks You Need To Own

Five seasoned stock pickers, who collectively manage in the tens of billions of dollars were asked to decide and select our list of America’s 100 Best Small Companies for gems worth a small-cap investor’s strict attention. They found 15. Here they are:

1. Solar Winds
Solar Winds
Ticker: SWI
Recent price: $22.46 (close of business, October 5)
Sales: $171 million (trailing 12 months)
Forbes pick by: Chris Faber

Solar Winds has nothing to do with either solar or wind power, but it does offer a powerful suite of software—delivered over the Web—used to monitor and optimize corporate computer networks. This “software-as-a-service model” costs less to implement than similar on-site management-platforms from the likes of Hewlett-Packard and IBM. Solar Wind’s 40% annualized sales growth over five years, along with its 30% profit margin, are sure to attract competition. Assume growth will cool off a bit, to 15%, implying a share price around $26.

2. HMS Holding
HMS Holding
Ticker: HMSY
Recent price: $24.30
Sales: $339 million
Forbes pick by: Chris Faber

This company—which makes money by saving Medicare and other programs billions of dollars a year in erroneous and fraudulent payments—was a darling last year among our gurus. (Three of the six picked it and the shares are up 21% since then.) Two of our six pickers still think HMS has room to run. According to the U.S. Department of Health and Human services, improper payments by Medicaid and Medicare programs totaled $70 billion in 2010. Two thirds of HMS’ top line comes from performance fees (it only gets paid if it helps clients reduce costs); the other third comes from service contracts—a stable, recurring revenue stream. For now, HMS has little direct competition. At a reasonable 25% growth rate, the stock is worth $44.

3. Ancestry.com
Ancestry.com
Ticker: ACOM
Recent price: $24.15
Sales: $354.4 million
Forbes pick by: Chris Faber

People are fascinated by their family origins, hence the TV hit Who Do You Think You Are? At the heart of those tales lies a proprietary, unique and massive database of legal, news and government records, courtesy of Ancestry.com, now with north of 1 million subscribers who pay access fees of $13 to $25 a month. Two challenges: Not everybody’s past is particularly interesting, and once people view the information, they may not feel the need to keep coming back. (Nearly half the customers don’t resubscribe.) To reduce churn, Ancestry adds new data—like recently digitized U.S. Civil War and slavery records. It is also experimenting with different pricing schemes to encourage more annual subscriptions. The moves have clouded growth forecasts, spooking investors and punishing the shares. Ancestry’s earnings are growing at a 30% clip; the market anticipates the rate soon will slow to 8%. Too pessimistic. Target price: $35.

4. Buffalo Wild Wings
Buffalo Wild Wings
Ticker: BWLD
Recent price: $57.86
Sales: $681.5 million
Forbes pick by: Chris Faber

Even in a lackluster economy, chicken wings and beer are basic food groups for throngs of rabid sports fans. BWLD’s same stores sales—up 5.9% in the last year—reflect that. Now with 277 company-owned and 492 franchised locations, Buffalo Wild plans to add 631 new restaurants over the next several years. The combination of loyal customers plus a larger footprint should produce 20% earnings growth over next 4 years. The market thinks it will be more like 15%. Our target: $70.

5. iRobot Corp
iRobot Corp
Ticker: IRBT
Recent price: $28.24
Sales: $422.6 million
Forbes pick by: Brandon Nelson

A pick on last year’s Best Small Companies list (the shares have since risen 33%), this maker of Roomba vacuum cleaners, Scooba floor scrubbers and PackBot bomb sniffers will continue to clean up. Home robots represent 60% of revenue, military bots the remaining 40%. Unrecognized is the coming expansion of gross margins, driven by increasing home-robot sales overseas (especially in Latin America and China) and moving more of the manufacturing over to low-cost ­contract manufacturer Jabil, which will be handling half the home-­bot load by the end of 2011—up from 10% to 15% at the beginning of the year. iRobot recently traded at only 19 times the $1.39 ­consensus earnings-per-share estimate for 2012, the lowest forward multiple in its public history. We think the shares will go to $43.

6. IPG Photonics
IPG Photonics
Ticker: IPGP
Recent price: $45.04
Sales: $402.7 million
Forbes pick by: Brandon Nelson

IPG Photonics owns 70% of the market for industrial fiber-optic lasers used to cut and weld parts for cars, planes and electronics. Fiber lasers are faster, more accurate, and use less energy than the traditional CO2-powered variety. Demand should rise in a variety of industries, especially from automakers aiming to use lighter and more easily sliced steel to comply with stringent fuel-efficiency requirements. The company also has the lowest cost structure among its rivals because it builds its own laser diodes—the expensive pumps that generate the laser’s light. Using special manufacturing techniques and eliminating shipping costs, IPG’s cost per watt dropped from $80 to under $5. (Competitors may follow suit on making diodes in-house, but not for at least a couple of years.) The shares have jumped 17%, to $53, since the time of this writing. If this company executes well, the shares are on their way to $70.

7. OPNET Technologies
OPNET Technologies
Ticker: OPNT
Recent price: $37.70
Sales: $157.1 million
Forbes pick by: Brandon Nelson

Corporate computer networks get clogged up all the time. OPNET’s software untangles them so that they run faster and more efficiently. It also runs diagnostic tests to tell you exactly why the pile-up occurred, unlike most network-management tools. Demand for this software will grow as networks get more complex; the trend has already attracted sizable competitors, including IBM and Computer Associates, which may have inferior products but wider distribution channels. This summer OPNET added six direct salespeople, upping its force to 79, and 32 resellers. At a recent 33 times the consensus 12-month earnings estimate, this stock isn’t cheap, but vigilant investors would be wise to buy on pullbacks.

8. BJ’s Restaurants
BJ’s Restaurants
Ticker: BJRI
Recent price: $44.61
Sales: $559.4 million
Forbes pick by: Brandon Nelson

Now with 110 company-owned locations (half in urban California), this casual pizza-pasta-sandwich chain with the nice beer selection isn’t slowing down. Same stores sales rose 5.6% in 2010 , versus -1.8% for Red Lobster, 2% for Cheesecake Factory, -0.1% for PF Chang’s, 1.2% for Ruby Tuesday and 1.2% for Olive Garden. Credit that performance to smart moves such as adding smaller tables and patio space to existing locations. Menu changes like “small bites” items, an enhanced kid’s menu and more tap beer options help, too, along with online ordering and delivery service and catering. The company expects to open 12 to 13 locations in 2011 and 15 in 2012. (More buying power should lead to higher gross margins.) At an average check of $13 a person, BJ’s would likely fare better than its pricier peers in a deteriorating economy. Target price: $60.

9. TEAM
TEAM
Ticker: TISI
Recent price: $24.47
Sales: $544.6 million
Forbes pick by: John Rogers

The company is the leading North American ­specialist in constructing, maintaining and repairing high-temperature and high-pressure piping systems for refiners and petrochemical producers. It’s a profitable niche, mainly because this is dangerous work. Better yet, 85% of the revenue comes from maintenance contracts—meaning that the company doesn’t have to chase down new customers all the time. Team’s balance sheet is ­pristine relative to others in the energy sector. During the last downturn many refineries scaled back temporarily on maintenance; that business came back strongly in the last year, as have new capital projects, particularly in Canada. At a recent $21 a share, or 12 times its forward earnings, the stock looks very attractive.

10. DG (formerly known as DG FastChannel)
DG (formerly known as DG FastChannel)
Ticker: DGIT
Recent price: $17.68
Sales: $256.3 million
Forbes pick by: William Schaff

The company’s software helps advertisers get the most out of each dollar spent on television, cable, radio, internet and print. Revenues are seasonal and tend to lurch with the news cycle, so this stock isn’t for the faint of heart. DG’s shares have suffered recently, after the company experienced explosive growth in 2010 (when earnings jumped 70% year-over-year on sales growth of nearly 30%). A few missed earnings expectations have cut the shares prices in half since May 2011. A spate of acquisitions starting in 2006 has boosted debt as a percentage of total assets to 40%. But those deals could help the shares bounce back, too.

11. Emergent Biosolutions
Emergent Biosolutions
Ticker: EBS
Recent price: $16.98
Sales: $283.9 million
Forbes pick by: William Schaff

The company develops vaccines, most notably for anthrax poisoning, which provides stable revenue as it searches for new oncology and immunology therapies. Emergent signed a 5-year contract, beginning January 1, 2012, to supply 9 million doses a year, a 28% jump from its typical annual production. In September 2011, the Dept of Health and Human Services issued a 369-page report from the Institute of Medicine that recommended building a store of anthrax vaccine before any crisis hits. The company’s balance sheet is fairly clean, with debt accounting for just 8% of total assets, and $88 million in cash. At a recent 14 times the 2012 consensus earnings estimate, the market is underestimating the company’s growth. Target price: $27.

12. Hawkins
Hawkins
Ticker: HWKN
Recent price: $32.90
Sales: $311.6 million
Forbes pick by: William Schaff

The company makes, blends and distributes a variety of specialty chemicals from acids to salts. Former CEO John Hawkins died this year and was succeeded by nephew Patrick Hawkins. His staff is motivated: The employee stock option plan owns nearly 16% of the outstanding shares. Industrial chemicals account for nearly three-quarters of sales; the remaining water-treatment segment is more profitable—29% gross margins versus industrial’s 17%. Bulls eschew the stock because earnings are down, even as Hawkins has racked up positive cash flow for the past 10 fiscal years. (Not many cyclical businesses can say that.) Its $23 million in cash and no debt will help in the coming downturn. At a recent $33, the stock traded at an enterprise value (market cap plus debt minus cash) of 7.5 times operating profit (Ebitda); that ratio should be more like 10, implying a $45 share price. And the 2% dividend yield does not hurt while you wait.

13. Exlservice Holdings
Exlservice Holdings
Ticker: EXLS
Recent price: $23.08
Sales: $295.6 million
Forbes pick by: Jim Oberweis

The company offers an array of services few companies would rather do on their own: collections, loan servicing, accounting processes and customer support. Long-term contracts provide stability. Its 28% growth in sales from its core operation (versus growth from acquisitions) far outpaced rivals WNS and Genpact, but the company does deals, too. Recently it expanded its customer base by acquiring OPI, another outsourcing firm but one focused specifically on finance and accounting arena, as opposed to the insurance industry, Exlservice’s bread and butter. At 17 times forward consensus earnings, the shares look cheap. Target price: $31.

14. HealthStream
HealthStream
Ticker: HSTM
Recent price: $12.68
Sales: $73.8 million
Forbes pick by: Jim Oberweis

This tiny company is a dominant player in the lucrative niche of health care training, both in-classroom and online. Customers (2.5 million of whom work for hospitals) include nurses, physicians and various emergency services personnel. The company also trains pharmaceutical and medical technology sales reps. Spending on these services generally is not considered discretionary, as continuing education and accreditation are mandated by both state and federal governments, making HealthStream a good play in a downturn. The shares aren’t cheap—they trade at roughly 3 times revenues–but stay alert and look to buy during pullbacks when they come.

15. Interactive Intelligence Group
Interactive Intelligence Group
Ticker: ININ
Recent price: $29.15
Sales: $192.2
Forbes pick by: Jim Oberweis

This company makes business software that manages everything from customer service calls to ­e-mail marketing campaigns. Giants like Avaya and Cisco make formidable rivals, but Interactive’s code easily integrates with existing software platforms, reducing the overall cost of using its product. The massive shift by corporations toward phone systems that run over the Internet versus traditional landlines will buoy demand. The company notched 2 big wins this year: Anchor Bank (beating out Avaya and ShoreTel) and window-dresser Blinds.com (formerly an Avaya customer). The other attraction here: $90 million in cash, or $5 a share, handy for acquisitions, which management has shown an ability to make work in the last 2 years. The shares are worth north of $40.

About Maffy Gondyi

Gondyi is a student of Psychology, a reserved personality, a critical thinker with an enthusiastic mind. He believes in making the world a better place; one word at a time. Mail me at [email protected]

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