7 Smaller-Company Stocks to Withstand a Possible Correction

NEW YORK ( TheStreet) -- Analysts expect a stock-market correction of as much as 5%. While that's possible, I remain constructive on the global economic recovery.

The first place I'd focus on is the U.S., as I believe underlying gross domestic product growth is running at 2%, and that the Federal Reserve's actions have led to a slow recovery. Housing is on the mend; banks are starting to lend again, and they have stronger capital positions; manufacturing is improving; and the consumer remains resilient.

That ties back to the wealth effect amid improving home prices and a better-trending job market, per the February jobs report and a number of sub-components within it -- plus sequentially higher temporary workers and hourly earnings. The four-week moving average of the weekly initial claims is now at cycle lows, and while the 7.7% unemployment rate needs to continue to improve, it was the best in four years.

Away from this, U.S. corporate balance sheets are strong, with $3.7 trillion in cash, and they are starting to use this for dividends, stock buybacks and a threefold year-over-year jump in mergers and acquisitions so far this year. Fourth-quarter earnings and revenue beat expectations, on average, and I expect this will continue to improve. After cutting costs and restructuring their businesses over the past four years, U.S. corporations are now more competitive, so margins can stay strong, even if they've potentially peaked.

I believe many global economies will post better growth this year, and if they do, revenue growth might continue to provide upside. Fund flows have been strong this year as well, with a 10% rise in January and a 4.1% gain in the past four weeks.

All is certainly not perfect, and several headwinds lie ahead: sequestration, the debt ceiling, questions about quantitative easing and monetary policy, Europe and leadership changes in Japan and China. But I believe the U.S. is on better economic footing to handle these issues. From a bottom-up basis, I can still find plenty of attractive stocks.

For the most part, we at Action Alerts PLUS own large-cap, blue-chip stocks. However, I've identified a few smaller-cap stocks that are interesting at current levels.

Allison Transmission ( ALSN) is a play on the trucking recovery, with strong margins driven by higher content per vehicle. It has strong cash flow, and earnings guidance has been set low.

Dollar General ( DG) is the premier dollar store and truly a best-of-breed. I like the consumables mix, the balance sheet and the square-footage-growth potential. And the lower oil prices should help the consumer. Shares are up 10% this year, but they're still down 15% from their highs.

HCA ( HCA) has scale advantage in the hospital sector and should benefit from the Affordable Care Act, as bad debt expenses will be reduced while volumes increase.

Hertz ( HTZ) is a play on the Dollar Thrifty acquisition and synergy benefits, wherein the top three rental-car companies will have a 90% market share. Hertz also has exposure to the improving trends in commercial construction in its equipment-rental division (HERC).

Ignite Restaurant ( IRG) will benefit from the recent Macaroni Grill acquisition. The takeout will help smooth out its seasonality and lead to better earnings and operating leverage, together with improved messaging and repositioning of its Joe's Crab Shack.

MEG Energy ( MEG) is a play on oil sands in Canada with above-average production growth, cash flow and return on capital employed. It's been successful in mitigating heavy differentials in Canada, and costs are well-controlled.

Finally, Nuance Communications ( NUAN) shares have been hammered this year, falling 17% after a disappointing quarter and guidance from weakness in its health-care and mobile segments. Offsetting this were better showings in enterprise and auto, as well as continued strength in its backlogs. Earnings will be back-half weighted and margins will be lower, tied to mix. However, shares trade at half their historical multiple average, and organic growth will still be a solid 8%. Plus, Nuance still dominates the speech-recognition market and could be a takeout candidate.

--Written by Stephanie Link, CIO & Co-Portfolio Manager of Action Alerts Plus.
 Chief Investment Officer, Co-Portfolio Manager of Jim Cramer's Charitable Trust, and Director of Research at The Street. Stephanie performs all portfolio management functions which includes developing a macro outlook and market strategy, thorough analysis and careful stock selection while managing the fund in a manner that allows subscribers to follow and emulate her thoughts and actions. She also writes a weekly summary report of the portfolio, highlighting strategy, latest analysis and ranking of each stock in the fund. Stephanie promotes the product through weekly videos, both independently and with Jim Cramer, which are featured on The Street's website. As Chief Investment Officer, she oversees all premium content which includes RealMoney, RealMoney Pro, OptionsProfits as well as other premium newsletters including Breakout Stocks and Stocks Under $10. Stephanie is a CNBC contributor and regularly appears on Fast Money Halftime, Closing Bell, Squawk Box and The Kudlow Report.

If you liked this article you might like

Alaska Air, Corcept Therapeutics, First Solar: 'Mad Money' Lightning Round

Alaska Air, Corcept Therapeutics, First Solar: 'Mad Money' Lightning Round

Markets Focus on Business: Cramer's 'Mad Money' Recap (Monday 8/28/17 )

Markets Focus on Business: Cramer's 'Mad Money' Recap (Monday 8/28/17 )

Bullish and Bearish Reversals for This Week

Bullish and Bearish Reversals for This Week

Allison Transmission (ALSN) Stock Stumbles After Q2 Results

Allison Transmission (ALSN) Stock Stumbles After Q2 Results

Allison Transmission Holdings (ALSN) Showing Signs Of Being Strong And Under The Radar

Allison Transmission Holdings (ALSN) Showing Signs Of Being Strong And Under The Radar