After the sky fell and the market crashed this past autumn, we're beginning to see glimmers of stabilization in certain corporate earnings reports. But even so, we remain in a recession that isn't likely to end until later this year.

However, that doesn't mean you shouldn't invest in the stock market now. Stocks will begin to appreciate before the recession is over.

In fact, small caps generally lead the broader equity market out of downturns, and this might be time to start positioning your portfolio in small caps to eventually ride the market out of its trough.

According to Russell Investments analyst Mary Fjelstad, over the four recessionary periods in the U.S. since 1979, the best time to invest in U.S. equities -- small-cap stocks in particular -- was, on average, far in advance of the end of a recession.

"Historical research has tested that, on average, small-cap stocks led large caps at 12, nine, six, and even three months prior to and after a recession's bottom, as well as at the exact moment of the trough itself," according to Stephen Wood, senior portfolio strategist at Russell Investments. "Investors who loaded up on small caps relative to large caps three and six months prior to the bottom and those who timed the bottom perfectly, had on average the best returns."

Building up small-cap exposure
For the long-term investor, trying to time that inflection point in the market clearly isn't necessary. In fact, small caps have a tendency to outpace their larger brethren as the economic operating environment improves. So let's start searching for those small caps!

To uncover winning small-cap companies, I ran a stock screen using The Motley Fool's CAPS screening tool. I looked for companies with:

  • Market caps between $100 million and $2.5 billion.
  • Return on equity of 17% or greater.
  • A current ratio of 1 or more, meaning the companies would be able to cover their obligations at least one time over.
  • Minimum earnings and revenue growth rates of 10% over the past three years.
  • Long-term debt-to-equity ratio of a maximum of 1, as it is more difficult for smaller companies to obtain credit in this market.
  • Price-to-earnings ratio of 20 or less.
  • CAPS ratings of five stars, the highest ratings from our CAPS community.           

Here's what I uncovered (and you can see the screen for yourself -- remember that results will be updated as the market changes):

Company

Market Cap (in Millions)

Price-to-Earnings (Trailing 12 Months)

Long-Term Debt-to-Equity Ratio

Current Ratio

Earnings-Per-Share Growth Rate (Past 3 Years)

Revenue Growth Rate (Past 3 Years)

Return on Equity (TTM)

Bolt Technology (NASDAQ:BOLT)

$105.9

9.8

0

13.7

34%

19%

19.3%

Diana Shipping (NYSE:DSX)

$1,238.5

5.6

0.31

3.4

29%

50%

28.6%

Dionex (NASDAQ:DNEX)

$1,049.3

18.7

0

2.3

19%

10%

28.1%

Dynamic Materials (NASDAQ:BOOM)

$252.3

10.6

0.38

2.3

13%

35%

20%

Endo Pharmaceuticals (NASDAQ:ENDP)

$2,022.1

8.5

0.29

1.7

16%

13%

19.3%

LSB Industries (NYSE:LXU)

$418.8

10.4

0.71

2.9

64%

19%

26.9%

VASCO Data Security (NASDAQ:VDSI)

$307.4

13.4

0

4.7

41%

29%

24%

Source: Motley Fool CAPS screen, as of June 3, 2009.

Aside from exhibiting robust financials, look for companies with unique products or services that produce great competitive advantages going forward. These attributes should put a company in a good position to pick up market share. Small caps that offer products that are unique are also better positioned to withstand the current economic conditions. After all, it is these attributes that lead to the strong top and bottom lines.

As always, using a screen through The Motley Fool's CAPS resource center is a great way to start, but your investment decisions should rely on your own research. Remain mindful of the stock's valuation, fundamentals, and growth prospects.

But you can start digging for small caps at Motley Fool CAPS today! Let the collective wisdom of our 130,000-member-strong investment community help you make better investing decisions.

For related Foolishness:

Fool contributor Jennifer Schonberger owns no shares of any of the companies mentioned in this article. Dynamic Materials is a Motley Fool Hidden Gems selection. VASCO Data Security International is a Stock Advisor pick. The Fool owns shares of Dynamic Materials and has a disclosure policy.