Frank Curzio is a research analyst for Jim Cramer and writes the Stocks Under $10 service at TheStreet.com . For more information about Stocks Under $10 and a free trial,
Small-cap stocks generally carry a higher degree of risk than large-caps because they don't generate as much cash, are less capitalized and are usually more volatile. Stocks that trade under $10 tend to carry an even higher degree of risk: Few research analysts cover the names in this group, and many of the stocks are completely out of favor with the public. However, the rewards of under $10 stocks can be impressive. To separate the bad stocks from the good -- the Vonages ( VG) and Sirius Satellites ( SIRI) from the Vasco Datas ( VDSI) and Allscripts ( MDRX), two stocks that now trade above $20 but began their run in the single digits (and have been members of the Stocks Under $10 model porfolio) -- start by following these three rules.
1. Review the Conference Calls for the Past Two QuartersThis is one of the first steps in our research process for the Stocks Under $10 model portfolio. After every quarter, companies provide a telephone number (or Web link) for investors to listen in as management outlines the financial results for the past three months. After management finishes with its presentation, analysts will ask questions about the quarter and usually inquire about the future of the business. After listening to many conference calls, we can confidently say that most executives usually highlight the positives of the quarter, no matter what the underlying performance may be. So that you don't get drawn into this rosy outlook, you should focus more on the concerns of the analysts asking questions. Also, even though headlines tend to highlight the revenue and earnings of a particular quarter, margins, new products, backlogs and subscriber growth are also key data that can influence the stock price.
2. Understand the Company's MarketBefore buying a stock, it is imperative that you analyze the sector. For example, a housing stock with high margins and solid earnings could seem like a low-risk, high-reward investment. However, a look at the overall housing industry will alert you that many of the stocks in this sector could continue to be under pressure for another 12 to 18 months because of tougher lending standards and higher inventories. That industrywide trend could pressure even the good names in the sector. Also, problems in some markets could lead to opportunities in others. Gasoline prices are skyrocketing, and small-cap retailers -- which receive most of their revenue from the U.S. -- could see a decline in traffic trends as consumers tighten their budgets. However, high energy prices are very good for oil and gas drillers.