5 Small Caps to Play a Market Bounce

How to Build a Wish List

5 Small Caps to Play a Market Bounce

The Next Microsoft

One of the fun things about being Chief Analyst of Cabot Small-Cap Confidential, even during a market downturn, is hunting for high potential small-cap stocks. While there are certainly exceptions, market corrections have historically offered up some of the very best bargains for long-term investors.

That doesn’t mean we should all go out and buy stocks simply because they are down. But it does mean that extra attention should be directed toward creating a watch list of stocks you’d consider owning in the future. When the market turns back up, this shopping list will save a lot of research time, and money can be quickly directed into those names that have convincing uptrends.

Here are five mid- and small-cap software stocks that are on my radar as potential buys for investors. With forecasts suggesting cloud software will drive 50% of all software investment through 2019 (equal to average annual growth of 18.3%), these stocks deserve a spot on any growth investor’s wish list.

Cornerstone OnDemand (CSOD) The $1.7 billion market cap company is a leader in the talent management market. It arguably has the best products for recruiting, training, managing and connecting employees, and has made intelligent investments to accelerating growth. You needn’t take my word for it though—for the third consecutive year, Gartner has ranked the company as a Leader in its 2015 Magic Quadrant for Talent Management Suites. The Leader ranking places the company in the same quadrant as SAP (SAP) and Oracle (ORCL). Gartner highlights the company’s outstanding customer satisfaction, sales momentum, ability to cross-sell multiple talent solutions and strong partnerships with partners, including Automatic Data Processing (ADP), Xerox (XRX) and Deloitte.

Cornerstone’s internally developed product suite is scalable and designed for complex, multi-national companies. It’s an asset that makes the company an attractive takeover candidate for a larger player. Over the last two years, revenue growth has averaged 46%, and EPS is projected to turn positive for the first time in 2016. The stock is about 20% off its 52-week high.

Tyler Technologies (TYL) Tyler Technologies has a $5.5 billion market cap and provides integrated information management solutions for the public sector. It services local government entities, including schools, counties and cities, which benefit from industry-specific software. It provides schools and local governments with software for financial management, courts and justice processing, regulatory planning, land and vital records management, and property appraisal and assessment services. There is little doubt that Tyler Tech is providing necessary, high-value services. And with local governments close to pre-recession spending levels and increasingly focused on efficiency gains garnered from cloud-based offerings, Tyler Tech is growing quickly.

Cloud-based offerings now account for nearly 20% of Tyler’s revenue. The company beat expectations in Q3, and reported revenue growth of 17.2% and EPS growth of 22.4%. Cloud-based subscription service growth was 28%. The sizeable acquisition of local government software firm New World Systems, which owns the Aegis software suite for firefighters and police officers, and Logos accounting software for city and county government officials is helping to keep the excitement in Tyler Tech high. But that hasn’t stopped the stock from dropping 12% from its 52-week high, despite expectations for 35% EPS growth in 2016.

Manhattan Associates (MANH) Manhattan Associates is a $4.2 billion market cap company that specializes in supply chain commerce solutions. In the early 1990s, Manhattan Associates primarily focused on warehouse management. But as the company grew and global supply chains became more complex and integrated with other business functions (accounting, lifecycle management, etc.), the company expanded to offer a full suite of supply chain software solutions. Today, Manhattan helps clients by integrating brick-and-mortar, catalog, website and mobile operations. Customers are retailers, wholesalers, manufacturers and governments. Examples include Adidas, Under Armour (UA), Papa John’s Pizza (PZZA), O’Reilly Auto Parts, Vera Bradley (VRA) and Columbia Sportswear (COLM).

Manhattan coordinates order fulfillment from manufacturer to customer—and everything in between. Customers need to reinvent their supply chains to meet the demands of the modern online consumer, and Manhattan Associates is one of the best pure-play providers in the market. The stock is 26% off its 52-week high, but expected revenue growth of 10% should get the stock moving higher again if the broad market firms up.

Synchronoss (SNCR) Synchronoss might just be the best software stock to play the connected world. Even though you probably haven’t heard of the $1.3 billion market cap company, you likely use its products. It develops cloud-based software and activation solutions for connected devices. This is the company that allows you to walk into a Verizon (VZ), T-Mobile (TMUS) or AT&T (T) store, upgrade your smartphone, synch all of your data and walk out within an hour. The company powers device activation software for all the major telecom and cable operators, not to mention original equipment manufacturers (OEMs) Apple (AAPL), Sony (SNE), Ericsson (ERIC) and Samsung.

These companies pay Synchronoss to activate devices, and to provide cloud-based storage for data and cross-device synching. It’s a pure-play investment on the connected world. And even though the stock is 41% off its 52-week high, expectations for revenue growth of 18% and EPS growth of 15% in 2016 could get the stock moving again this year.

Reis (REIS) With a market cap of just $240 million, Reis is by far the smallest company on this list. It provides software and analytical tools for commercial real estate professionals, and also maintains a proprietary database of information on commercial properties across the U.S. This data is used by clients as well as debt and equity investors who need to assess the risks of default and loss associated with mortgages and real estate-backed securities. Recent initiatives include expanding its coverage into both senior housing and student housing markets.

Reis has shown impressive growth and profitability in recent years, so much so that it even pays a 2.6% dividend. Annual revenue growth has averaged 15% over the past four years, and average EPS growth has been 80%. Expectations for 85% EPS growth show that trend holding up in 2015, but for some reason, 2016 EPS growth is forecast to be -24%. I don’t know exactly why, so if you’re considering this stock, it’s probably worth doing a little digging, and even waiting until the fourth-quarter report is in to see what management’s latest forward guidance is.

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Last Chance to Reserve Your Spot

At midnight, we’ll be closing the doors to our Cabot Small-Cap Confidential 2.0 investment advisory.
I hope you’ll want to join us because our expanded coverage of revolutionary technologies and biotech breakthroughs could hand you 100% to 200% annual gains every year for the rest of your life. 

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The Next Microsoft

There are a lot of great software stocks out there that are growing quickly. Even many large caps, like Microsoft (MSFT), are doing well in this market. I own Microsoft. In fact, I last added to my position in February 2015 at 43, 21% below today’s price. Not a bad deal!

I like Microsoft, and it’s a stock I expect to keep buying over time. With a little luck, the dividends will cover some of our expenses in retirement. But it’s Microsoft—far from the highest potential stock on my watch list right now.

Rather, I’m spending more time trying to uncover the next Microsoft. And that means building a watch list of potential ideas. For those ideas to move from the watch list to the buy list, they have to clear several critical hurdles:

• They need to be pure-play small caps that are benefiting from a long-term growth or recovery trend.

• They need to have great business models.

• They need to have excellent products now and show evidence that more excellent products are coming in the future.

• And they have to show solid fundamentals, including revenue and earnings growth. Even if they’re not profitable now, the earnings trend needs to be up.

• I also need to identify at least a few upcoming milestones and events that can energize shares and build long-term shareholder interest.

• And lastly, the window of opportunity to establish a position has to open. And that often comes during market corrections such as this—provided there is no negative change in the underlying growth story.

Most investors aren’t out there looking for high-potential small caps during markets like this. But that’s their mistake! They could miss out on opportunities like this one, which was trading near its 52-week high in November, right before the market turmoil hit.

There is no negative news that has been revealed specific to the company. It has a gross profit margin of 89% and revenue growth will most likely be over 30% in 2015 (Q4 results aren’t out yet).

Yet the stock has been slammed as the broad market dips.

This is the kind of stock I’m looking for every day. And it’s the kind of stock I cover in Cabot Small-Cap Confidential 2.0 every month. If you’re interested in finding out all the details on the stock mentioned above and best stocks from my watch list with every issue, consider becoming a regular subscriber.

To learn how, click here.

Sincerely, 

Tyler Laundon
Chief Analyst of Cabot Small-Cap Confidential 2.0

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