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.

Today we'll screen for stocks that have less than $3 billion in market cap, earnings surprises of 15% or more in the previous quarter, and long-term earnings growth forecasted to be at least 15%. We'll then filter our findings through the collective investing wisdom of the Motley Fool CAPS community and those they think have the best chance for 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)

Digital Generation (Nasdaq: DGIT  ) $347 million 100% 15% ****
Goodyear (NYSE: GT  ) $2.8 billion 386% 44% **

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.

Taking aim at growth
With a stock that's more than 60% off its 52-week high, Internet marketing and advertising provider Digital Generation, formerly known as DG FastChannel, is attracting the attention of investment firms that see promise in its operations. Previously an advertisement management specialist, Extreme Reach had offered the company $20 a share that was rejected, and now RDG Capital is sending out feelers to see what price it would take to get a takeover agreement.

It's not as if Digital Generation isn't interested, as it's apparently working with Goldman Sachs to find potential suitors. Last year it tried to sell itself back when it was known as DG FastChannel, but after making an acquisition of its own, the effort went nowhere.

That's a lot like its operations, which have suffered of late with profits in the latest quarter falling under $1 million from $12.7 million last year. Rising costs have been a recurring issue with the advertising agent. Its most recent quarter saw revenues jump 46%, cost of revenues climb 53%, sales and marketing expenses quintuple, and R&D rise 160%. Much of the increases can be laid at the feet of the acquisitions it made, most of which had heavier expenses.

It faces lower ad volumes and tighter competition from Akamai (Nasdaq: AKAM  ) and Limelight Networks (Nasdaq: LLNW  ) , which are making a strong push for delivering content to both established outlets and new media, as well as from Extreme Reach and even Google and Comcast, which deliver television advertising spots to satellite TV systems, broadcast TV stations, and cable networks.

CAPS member GirlsUnder30 admits DG has made some mistakes along the way but, as a pioneer in the space, believes it will come out on top: "Online advertising is inevitable but the technical and political hurdles of delivery in this medium are substantial so the first ones doing it are the most likely to succeed."

Tell me on the Digital Generation CAPS page or in the comments box below what price you think it will ultimately accept, and then add the stock to your Watchlist to see who ultimately makes the winning bid.

Burning rubber
Tire maker Goodyear also got a boost from private-equity interest in its stock, but don't expect SAC Capital to make a bid on the stock. Steven Cohen is probably just interested in the depressed shares, which are down 22% from the year-ago period and 37% from their peak. I think he has good reason to expect a turnaround.

While Goodyear, Michelin, and Cooper Tire & Rubber (NYSE: CTB  ) have been weighed down by the commodities crush that saw prices soar, we may now see that trend reversed, providing an extra boost to the bottom line.

Goodyear has said it expects commodities costs to increase 12% in the second quarter and be up 9% for the full year, but rubber prices are in freefall, dropping 23% this quarter and may fall another 20% by year's end. Bridgestone, the world's biggest tire maker, is seeing its costs drop precipitously as a result. The glut, as it's becoming, is built primarily on China's economic slowdown, which is leading to a drop in demand. With oil prices also easing -- two-thirds of Goodyear's raw materials are oil-based -- it should get some relief on that front, too.

Carmakers are heading toward a seasonally adjusted annual rate of production of close to 14 million vehicles, which makes the industry achieving a nice recovery. That leads CAPS member Prodders to see Goodyear recovering, too: " Potential 2x or better here, now that they've turned their focus to high end tires, with input costs falling lately and potential for further pick-up in autos demand. Peak earnings of $3 have become possible."

I've rated Goodyear to outperform the market averages on CAPS, but let me know in the comments section below or on the Goodyear CAPS page whether you think it will ride reduced expenses to higher returns, and then add the stock to the Fool's free portfolio tracker to see whether it can burn up the charts again.

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 Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of Google and Goldman Sachs. 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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