In our second installment of the Small-Cap Spotlight, we're going to take a look at Jones Soda (JSDA) , the beverage maker and distributor that has made headlines this year as the David to the twin Goliaths of soda -- Coke (KO) - Get Report and Pepsi (PEP) - Get Report.

For those who haven't been following this story, Jones has staked its claim in the beverage industry with its

distinctive flavors and labels, as well as its dramatic move to use pure cane sugar -- rather than high-fructose corn syrup -- in all of its products.

During the first five months of 2007, investors have seen shares of Jones Soda rocket as the company launched its products in cans and announced an attractive set of retailers that will carry its soda, including

Wal-Mart

,

Kroger

and

Safeway

. Let's begin with Larsen's take on the upstart.

Kusick: Step Up to the Soda Bar

The expansion into canned soda is important because many retailers prefer cans to glass bottles (thus boosting sales), and margins are about 10% higher than for bottled soda, which have margins of around 35%. However, the expectations of analysts and investors proved overly optimistic as Jones posted

disappointing first-quarter results a month ago, including just 1.1 million cases of concentrate sold during the quarter. This number was shockingly low considering that Jones sold 1.9 million cases in the last six weeks of the previous quarter.

Since the announcement, shares of Jones Soda have continued to sell off as investors re-evaluate their assumptions for the company's future. And although the company scored a significant win in late May when it announced that it beat out Coca-Cola to become the sole provider of nonalcoholic beverages at Qwest Field, the home venue for the NFL's Seattle Seahawks, the stock has remained in a steady downtrend.

In hindsight, it's obvious that Jones Soda's stock rocketed too far, too fast as shares went from $12 on March 1 to above $32 on April 16 (that's almost a 170% gain in 32 trading days). However, investors looking for a growing company with a differentiated product have to be wondering, 'At what point is it time to consider buying?'

Simply looking at the run that shares have made -- to $32 from $12 and back to $17 recently -- this is obviously a risky stock. But with shares now trading about 45% below their 52-week high set less than two months ago, I believe aggressive investors who missed this play earlier in the year are getting an attractive risk/reward.

While the vast majority of recent stories have highlighted Jones Soda's recent disappointments, let's review the positives.

The company has the only truly differentiated product in the cola/soda market, which is dominated by Coke and Pepsi. No one in his right mind would say that Jones will capture enough market share to be a true rival to these giants, but there is a ton of room for the company to penetrate the market using its established "outsider" brand and alternative flavors. For an idea of how big this opportunity is, Coke and Pepsi control more than 70% of the multi-billion-dollar cola-beverage industry.

Investors should also keep in mind the earnings growth potential that Jones has. Even after the recent earnings miss, adjusted analyst estimates have the company growing revenue and earnings per share at a 42% and 31% clip, respectively.

More importantly, 2008 consensus analyst estimates show revenue continuing a healthy growth rate of 33%, with earnings jumping 94%, to 33 cents a share. Shares still aren't what I would call "cheap" -- they're trading around 55 times 2008 earnings estimates. But Jones will never be the kind of stock that has a price-to-earnings ratio that attracts deep-value investors. Trying to find hyper-growth companies in the small-cap space that are trading at a more "reasonable" 20 to 30 times forward earnings is a tall order.

Keep in mind that the selloff in the stock has been driven by questions over whether these strong 2008 results will in fact materialize. Recent media articles on Jones Soda have all focused on the negative side of the story, which makes me believe that now is finally the time for aggressive investors to make a move on this high risk/high reward play.

Another key data point for investors to consider is the large short position in Jones. Most recent data from May 10 shows that more than 26% of the outstanding float was sold short. That number is likely higher now that shares have sold off another 4 points, or about 20%.

This big short position provides fuel to propel the stock when it finally bottoms, and also serves as an indicator that there are a lot of traders who are already expecting bad numbers going forward. Just as we now can see that shares were overbought at $32 in mid-April, the selloff will be overblown and shares will be oversold at some point. Of course, we'll only know where the bottom is for Jones

after

the shares rally, but following the steep decline, I feel confident saying that the upside for investors is now greater than the downside.

For investors who want to grab a piece of this company here but feel uncomfortable buying into the downtrend, I suggest a similar strategy to the one I mentioned

last week

regarding

Crocs

(CROX) - Get Report

-- i.e., picking up half a position here and leaving room to pick up the other half a point or two lower.

Curzio: This One's Too Bubbly

Jones Soda has been under pressure since reporting first-quarter results that were well short of estimates. Adding to this trouble was a negative article from

Barron's

citing valuation concerns. Shares are now down roughly 45% in the past 45 days, and I would not be a buyer here.

While Jones Soda has always been viewed as an expensive stock, it had the growth model -- as Larsen outlined above -- to back up its share price. So when earnings came in flat for the quarter, it was not surprising to see the stock fall so much.

Looking at the

Barron's

column, the article cites that Jones Soda should be trading at $7 based on valuation comparisons to Pepsi, Coke and

Hansen Natural

( HANS). However, let me be the first to point out that the same newspaper said

Google

(GOOG) - Get Report

was worth $188 a share using similar metrics, so I will not base my argument on its opinion.

My call to avoid the stock is simply based on sentiment. As I mentioned in my

small-cap video

from three weeks ago -- when shares were trading at $22 -- if a growth company with a very high valuation misses estimates, it's cause for concern. If they miss two times, it usually means business is bad and it's time to sell.

We are currently in the transitional period for Jones Soda, and investors need to ask themselves whether the latest quarter was a hiccup or a sign of more bad news to come. After reading through some analysts' reports, which included a downgrade, a 40% reduction in 2007 case volume and a target price removal, I am not convinced that Jones Soda will bounce back with a solid quarter.

I wouldn't buy Jones' shares at its current levels.

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