Three Tough Small-Caps

Although picking stocks in this environment is certainly fraught with risk, when the decline is over and a new bull market begins, owning stocks that have leadership potential will be much more profitable than simply investing in the market averages.

My favorites tend to be small-cap selections. This imparts a higher degree of risk, but here are three stocks that should weather an economic downturn better than most and still have potential to lead a new bull market.

In a difficult job market, perhaps more of the labor force will elect to go back to school to acquire new career training. Lincoln Educational Services (LINC - commentary - Cramer's Take) offers training and degree programs in five areas including business and information technology, health sciences and automotive technology. The company has 35 campuses in 17 states. Revenue growth in 2007 was only 3.7%, but growth has accelerated this year, and the company projects revenue growth of 12% to 13% for 2008.

Student population as of Sept. 30 was up 15.1% compared with the same time in 2007. Earnings have been increasing nicely as well. In the third quarter just ended, the company reported diluted earnings per share growth of 29%. The company has spoken positively about its outlook for 2009.

Valuation is extremely low for this company. Lincoln has a current price-to-earnings ratio of 22 times compared with the industry ratio of 28. The price-to-cash-flow ratio is only 10.7 compared with 22.1 for the industry. Finally, the company has an enterprise value-to-EBITDA ratio of 7.5, a 40% discount to the median company in the education and training services industry.

I have a trucking company on my list. The trucking industry has historically been a group that leads the market out of periods of recession. My favorite is USA Truck (USAK - commentary - Cramer's Take), a dry van truckload carrier operating in North America. The key to operating a successful trucking company is to pay attention to the details that lead to solid profitability. These details include velocity and yield management, mileage utilization and driver quality.

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At the time of publication, Moore was long LINC, USAK and SMTB, although positions may change at any time.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider LINC, USAK and SMTB to be a small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices. Richard Moore, CFA, has 40 years of experience in various facets of the investment business. He has been employed by banks, mutual funds and investment advisory organizations during his career and has also owned retail and service businesses. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Moore appreciates your feedback; click here to send him an email.