Start Small, Win Big

Wall Street pros have nothing on retail investors who stake small sums of money monthly on undervalued small-cap stocks. Because the big guns mostly ignore them, these types of stocks offer the best outsized opportunities for growth.

We'll screen for stocks under $3 billion in market cap that offer earnings surprises of 15% or more in the previous quarter and a long-term earnings-growth forecast of at least 15%. We'll then filter our findings through the collective investing wisdom of the Motley Fool CAPS community and look at what they think has the best chance at winning.

Here are some of the stocks this simple screen found.

Company

Market Cap

EPS Actual vs. Estimated

Average Analyst 5-Year EPS Estimate

CAPS Rating (out of 5)

8x8 (Nasdaq: EGHT  ) $284 million 33% 26% ****
American Capital (Nasdaq: ACAS  ) $2.95 billion 235% 15% ****

Sources: Yahoo.com and Motley Fool CAPS.

Of course, this is not a list of stocks to buy -- just a starting point for more research. We need to look more closely at these companies to see whether analysts' faith in them is well founded.

Testing new highs
If consumer-oriented VoIP providers Vonage (NYSE: VG  ) and MagicJack (Nasdaq: CALL  ) haven't been able to make much of a dent in customer penetration, then it would seem an uphill battle for enterprise-facing 8x8 to make headway among stodgier business customers.

Yet revenues soared 31% and its customer churn dropped to just 2%. Not content on just providing VoIP telephony services, it now offers customers a suite of products and abilities, including voice mail, call-center services, and more, giving clients a complete virtual office. And where it previously focused exclusively on small and medium-sized businesses, it's now targeting enterprise-class clients too.

I've noted before that as much as I like 8x8's prospects (I've rated it to outperform on CAPS, too), there is risk involved in an investment. Going after different types of businesses than its accustomed to and potentially seeking international growth are just two of them. Yet so far it's making all the right moves, as the number of paying customers has grown 35% since early in 2010, while the number of services those customers subscribe to have grown as well, and customer acquisition costs are down.

Those kinds of results are probably the reason 96% of the CAPS members rating 8x8 see it outperforming the market, while less than a third of those rating Vonage and just over half of those weighing in on MagicJack see a similar outcome.

Tell me on the 8x8 CAPS page whether you think it will dial up new highs, and then add the stock to your Watchlist to watch how it tackles new markets.

Developing a hankering for growth
Business-development company American Capital has been using the resurgent economy to peel off businesses and reduce its operating costs in the process. Moreover, it's initiated the possibility of dividend payments that were suspended when it nearly slid into oblivion. It's lately been using funds to repurchase shares instead to returning value to shareholders.

Over the past six months, American Capital has divested itself of three businesses, and after repurchasing nearly 18 million shares in the second half of last year, it just announced that it bought another 5.5 million shares in the first quarter.

Ares Capital has also been benefiting from the improved environment, reporting earnings that handily beat analyst expectations. Fortress Investment Group (NYSE: FIG  ) , however, hasn't fared so well. It missed profit forecasts, income from its principal investments fell, and managers saw incentive income drop. Coupled with its CEO's resignation in the wake of being named in a lawsuit for his stint as CEO of Fannie Mae, it was a rough period for the investment firm.

More than 2,000 CAPS members have weighed in on AmCap, and 95% see it continuing its climb higher. But add American Capital to the Fool's free portfolio tracker and tell me in the comments section below whether you think it will continue to realize profits from additional investment divestitures.

Foolish final thoughts

These companies may have the odds stacked against them, but The Motley Fool has identified two stocks that are also facing difficult times yet still grow revenues hand over fist. The report is free, but it's available for only a short time, so ask for your copy today and find out the two cash kings that are changing the face of their industry.

Fool contributor Rich Duprey holds no position in any company mentioned. Check out his holdings and a short bio. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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