I am always in search of growth stocks. I am also always seeking out stocks that have unique blends of financial metrics that line up to try to help whittle an investment edge — either on the long or short side.
Recently, I decided to seek out some excellent growth candidates by taking a look at small-cap stocks with market capitalization below $1 billion that were members of the Russell 3000 Index. To achieve the growth characteristics of my search, I further screened out stocks with price-earnings-to-growth, or PEG, ratios that were less than 1. In other words, these stocks are selling at a discount to their earnings growth. I made sure to eliminate stocks that carried any debt.
I wanted to be contrarian and culled out stocks with high short interest ratios. In other words, I sought out small-cap growth stocks that many people were betting would fail.
Then I performed a fundamental review of these stocks to select those with business models that I felt were consistent with my economic outlook.
What I arrived at was a portfolio of five small-cap growth stocks with high short interest. Let's take a closer look.
Integrated Silicon Solutions
Integrated Silicon Solutions is a specialty memory chip manufacturer that focuses on products for the communications, consumer products, automotive, industrial, medical, and military end user. The company designs products in the U.S. and then outsources production to the Far East, much like Apple does. Customers include a huge cross section of the companies in the S&P 500 and global large-capitalization tech companies.
Nearly 4 percent of the stock is sold short , with the short ratio hovering around 11. This high level of short interest, I believe, is due to a near-500-basis-point decline in gross margins for the fiscal year ended September 2011. This occurred despite revenue climbing nearly 8 percent for that year.
The company recently reported first-quarter 2012 results that disappointed on the top and bottom lines. Perhaps the shorts saw that coming. But the stock did not react as the shorts expected; it held its ground. To me, this means that there is so much negativity in the stock that any positive news will propel it higher.
With Integrated Silicon Solutions selling at about eight times earnings with about $3 per share in net cash, and with my expectations for an improving tech market for 2012, the stock can surprise to the upside in the future.
Insperity provides one-stop shopping human resource services for small and medium-sized business. Its services include payroll processing, benefits, human resource administration, workers compensation, insurance, compliance, expense management, and technology services to business that are trying to grow and not get bogged down in these costly and time-consuming activities.
Small business creation has been challenged in the last few years, but there is evidence that trend may be slowly reversing, and analysts expect Insperity's earnings to grow by 30 percent in 2012. Nevertheless, the stock sells for only 22 times trailing earnings and 17 times forward earnings.
The company bettered earnings expectations for the last four quarters. Cash and short-term investments account for nearly $10 of the $28 stock price. The stock's yield of 2.14 percent is just above the market average.
In the face of all of those positive signs, short positions represent nearly 4 percent of outstanding shares and a short ratio of nearly nine. Insperity could inspire your portfolio in the future.
Transcend Services provides technological solutions to doctors, hospitals, and other health-care services. In particular, Transcend provides speech-recognition and documentation services, which reduces cost and increase efficiency for health-care providers.
You might be aware of a company that provides speech-recognition services to consumers, Nuance Communications. Nuance manufactured the popular Dragon voice recognition product. Transcend takes the Dragon concept one step further by specializing in medical transcription and then providing outsourced solutions.
The company is expected to grow earnings by 45 percent in 2011 and by 15 percent in 2012, yet the stock trades at only 18 times trailing earnings and 16 times forward earnings. The shorts don't necessarily buy into the story at Transcend as about 6.5 percent of the outstanding shares are sold short with nearly a 13 short ratio. The increasing documentation burden that medical professionals and facilities are having placed upon them by the government, insurance companies, and legal profession will provide fertile growth opportunities in the future for Transcend.
Rue21 is a specialty clothing retailer focused on the teen/tween/young adult consumer. Make no mistake about it, Rue21 has a very fickle customer base as can be seen by the ups and downs of many of its competitors in the industry such as Aeropostale, Abercrombie & Fitch, Urban Outfitters, and American Eagle Outfitters.
The year 2011 was a tough one for this sub-sector. With the exception of Abercrombie & Fitch and Rue21, all of the other companies experienced significant earnings declines in 2011.
Rue21 is expected to grow earnings by 25 percent in 2011 and 15 percent in 2012. The company is on an expansion program that should help feed future growth. I believe that the current year's estimates may be on the low side by as much as 5 to 10 cents.
This stock is heavily shorted, with nearly 40 percent of the float being short and a short ratio of about 13. Any surprises to earnings could send this stock into a major short squeeze.
Dorman Products produces original-equipment dealer replacement parts for automobiles. One lingering result of the financial crisis is that the age of the existing fleet of cars in the U.S. is at a record high 10.8 years. As a result, consumers and even commercial operators of automobiles have been spending more money repairing their existing vehicles.
The company is expected to increase earnings by 16 percent in 2011 and 14 percent in 2012. The stock sells at 13 times forward earnings, a discount to its growth rate. Short-sellers think the stock will break down alongside the road and have shorted about 5 percent of outstanding shares with a short ratio of about 13.
Dorman Products might not be a sleek high growth sports car, but it is cheap by the numbers and it too heavily shorted.
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