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Investment Ideas

Everyone knows the big cap stocks because everyone owns them. You know the names: Apple, Google, Johnson & Johnson, McDonalds. I could go on and on. Some of the large caps, like General Electric, have been around for over a hundred years.

There's nothing new or unknown about any of these companies. As an investor, they make you feel safe. The large caps are like a trusty childhood blanket.

But small cap companies are different. There's an air of mystery about many of them. They're usually not in the news much. Few analysts tend to cover them. Most average people on the street have never heard of them. They seem scary and risky.

So why buy them?

Because the returns can be far greater on a fast growing small cap company than a stodgy, slow growing big cap.

But you have to know where to look because not all small cap stocks are created the same. Some companies aren't profitable. Some consistently miss earnings estimates. Others aren't growing as quickly as they should be.

It's easy to get sucked into a small cap nightmare.

Finding the Best Small Cap Stocks

To reduce the risk, I came up with a list of criteria for my "dream" small caps.

1. It must be a Zacks #1 Rank (Strong Buy)- which means that there is at least one analyst covering the company and the estimates are likely rising.

2. It has to be profitable. Show me the money!

3. There must be double digit earnings growth forecast for 2013. If I'm going to buy a small cap, I want to be able to cash in its explosive growth.

I then screened stocks using Zacks Research Wizard to find the best stocks that matched my criteria. I had several dozen stocks to choose from but I also wanted companies in different industries that also had good stories. Here's what I found.

3 Dream Small Cap Stocks

  • Hooker Furniture
  • Big 5 Sporting Goods
  • Tower International

1. Hooker Furniture (HOFT - Snapshot Report)

Hooker Furniture makes wood furniture including home entertainment, home office, accent, dining and bedroom furniture in the upper-medium price points under the Hooker brand and in the moderate price point under the Envision Lifestyle Collections brand. In business sine 1924, the Virginia-based company has seen a lot of different business cycles.

The furniture industry is picking up momentum as housing picks up momentum. In April, the company reported fiscal 2013 results which saw net income rise 71% compared to fiscal 2012. The upholstery segment, for example, returned to profitability in fiscal 2013 after reporting operating losses all the way back to the second quarter of fiscal 2009. In the fiscal fourth quarter of 2013, sales in the upholstery segment rose 10.4%.

The company has $26.3 million case on hand as of Feb 3, 2013, which is down $15.7 million from a year ago due to an increase in inventories. Hooker is making sure it has its best sellers in stock as momentum increases. More impressively, the company had no long-term debt. $13.2 million was also still available on its $15 million revolving credit facility with $1.8 million reserved for standby letters of credit.

"We're encouraged by the sustained improvement in housing sales, new home construction, rising housing prices, reduced housing inventories, historically low mortgage rates and the best housing affordability in years. All of this bodes well for our industry," said Paul B. Toms Jr., chairman and CEO in April.

Zacks Rank = #1 (Strong Buy)
Expected earnings growth for fiscal 2014 = 18.8%
Forward P/E =18.1
Market Cap = $184 million

The housing plays aren't a secret anymore. Hooker shares are trading near multi-year highs.

2. Big Five Sporting Goods Corporation (BGFV - Analyst Report)

The consumer is alive and well in America. Big 5 Sporting Goods operates 414 stores in 12 western states that sell sporting goods and accessories including athletic equipment for team sports, fitness, camping, hunting, fishing, snowboarding and in-line skating.

On Apr 30, the company reported fiscal 2013 first quarter results and blew by the Zacks Consensus by 62%. Same store sales jumped 10.5% even though they were negatively affected by the Easter holiday, which was in Q2 last year. The company shuts its stores on that day.

"We believe these results for the quarter reflect the ongoing enhancements to our merchandise and marketing programs, the continued benefit from the national increase in demand for firearms and ammunition products and more favorable weather conditions in a majority of our markets versus the prior year. Our positive sales trends have continued into the second quarter and we feel well positioned to deliver strong results as we move through the spring and into the summer season," said Steven G. Miller, Chairman, President and CEO in April.

Zacks Rank = #1 (Strong Buy)
Expected earnings growth for fiscal 2013 = 77%
Forward P/E = 16.2
Market Cap = $450 million

As an added bonus, investors get a dividend which is currently yielding 1.9%. It's unusual to see a small cap company pay a dividend, let alone one that is this hefty.

3. Tower International (TOWR - Snapshot Report)

The auto industry has staged a powerful rebound from its Great Recession lows. Tower International has been able to cash in on the turnaround as it makes body-structure stampings, frames and other chassis structures, as well as welded assemblies for cars, crossovers, pickups and SUVs in 29 locations around the world.

On May 2, the company blew away the Zacks Consensus Estimate for the first quarter by 256%. Earnings were 32 cents compared to the consensus of just 9 cents. Revenue was up just 1% however as a struggling Europe saw lower industry production. All other regions were higher in the quarter however.

It also completed an early debt tender and re-financing which is projected to improve ongoing free cash flow by about 75 cents per share annually.

Tower raised full year guidance by 40 cents. As a result, 3 estimates have moved higher.

Zacks Rank = #1 (Strong Buy)
Expected earnings growth for 2013: 52%
Forward P/E = 12.2
Market Cap = $399 million

Want More of Our Best Recommendations?

Zacks' Executive VP, Steve Reitmeister, knows when key trades are about to be triggered and which of our experts has the hottest hand. Then each week he hand-selects the most compelling trades and serves them up to you in a new program called Zacks Confidential.

Learn More>>

Tracey Ryniec is the Value Stock Strategist for Zacks.com. She is also the Editor of the Turnaround Trader and Value Investor services. You can follow her on twitter at @TraceyRyniec.

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