Arm Yourself With Explosive Under $10 Stocks

DynCorp's niche was training police forces in the Middle East, and the company was more on the services side and less of a manufacturer of weapons. This was a huge positive, given that police forces would have to be trained in the Middle East in order for U.S. troops to return home. Also, military spending would likely be pushed into training and rebuilding rather than weapons, considering that the U.S. was past the heavy combat stages in Iraq.

When we analyzed the weak quarter before our recommendation, investors seemed more concerned with the actual numbers and less about the reasons behind the miss. For example, earnings and revenue were on the light end of estimates, but DynCorp's backlog and cash flow increased for the quarter. Also, growth from its three largest contracts continued to gain momentum.

Its balance sheet was rife with debt at the time, but the company had just come public less than six months before, and management had significantly reduced its debt balance over the past 18 months. The debt-to-equity ratio stood at 65% -- much higher than the industry average of around 45%. -- but with nearly zero capital expenditures and forecasts for substantial cash flow over the next year, the reward seemed far greater than the risk.

Next, we listened to the conference call for DynCorp and, despite the miss in earnings, we came away very impressed with management - specifically Herbert Lanese, DynCorp's CEO. Lanese is not a politically correct type of guy, and his responses to some questions from the sell-side analysts could be quite entertaining.

Lanese's focus is clearly on the longer term. His belief that DynCorp will be a significant beneficiary of future contracts due to the increase in defense spending was easily translated to anyone listening to the call. The interesting part is that hardly anyone was able to recognize it, because DynCorp was on few radar screens given its recent entry into the public markets and its limited coverage by a handful of sell-side analysts.

Following the call, we knew that DynCorp would be in the Stocks Under $10 model portfolio, but we wanted to get the best price, which sometimes requires patience. Sure enough, investment firm Wachovia downgraded the stock on Nov. 11 to neutral from buy, which pushed shares lower. Later that day, we used the selloff to initiate our position at just under $10.50.

Since our recommendation, DynCorp nailed a $4.6 billion linguistics contract from the U.S. Army, beating out L-3 Communications LLL , one of the major defense contractors. Also, DynCorp was one of three firms chosen by the U.S. Army for the $150 billion LOGCAP (Logistics Civil Augmentation Program) contract, an initiative for peacetime planning for the use of civilian contractors in wartime.

Lanese's long-term outlook was dead on, and shareholders have clearly benefitted. Today, DynCorp is still in our model portfolio, and the stock is up 125% since our initiation. We believe that shares could hit $30 during the next 12 months.

DynCorp is a Stocks Under $10 recommendation. Frank Curzio and his team assemble a winning small-cap portfolio, including alerts when they buy and sell, and a detailed weekly roundup that recaps their holdings, which also include Taser TASR, Xoma XOMA, Sirius SIRIand China Direct CDS.