The Microcap Speculator

Don’t bother with that 380 page trading book.  Ron Sen has distilled the traps that traders need to avoid down to a single page.  Read this, follow it, and you will be ahead of 99% of traders.

After more than a year, I am back in Highway Holdings (HIHO), a Chinese manufacturer of parts, components and sub-assemblies.   First, a word of caution: this is a very thinly traded stock.  When I placed my order last week, the bid was at $1.26 and the ask at $1.39 — roughly a 10% spread.  It took all day just to fill my initial buy of 10,000 shares.

Stocks trading that thinly require a whole new level of patience, but can be quite rewarding.  Today is a good case in point.  With volume edging over 60,000 shares — a heavy day for HIHO but a pittance for most stocks — shares rose over 23%.  The leap even put the stock on this afternoon’s Century Club scan,

Get an updated  HIHO trend analysis or a risk free trial of MarketClub (unlimited live, real-time signals with audio interpretation) courtesy of Ino.

I have no idea what catalyst caused today’s action, but its easy to see why HIHO shares were more likely to rise than fall.  Even after today’s jump, HIHO trades below its cash position of $1.80 per share.  Shareholder equity is nearly $3.00 per share, and while results have suffered along with the global company, Highway Holdings was profitable last quarter.  Roland Kohl, President and CEO gave this outlook:

Despite a worldwide economic slowdown, the company was able to achieve an increase in net sales in fiscal 2009 and return to profitability. However, demand for manufacturing services in the short term is still weak and is not expected to regain momentum until our international customers gradually start increasing their orders to restore depleted inventories to meet anticipated consumer demand as the global economy slowly recovers. The business environment, near term, therefore, continues to be challenging and unpredictable — with sales for the first fiscal quarter expected to be soft, based on current order flow. Nonetheless, we believe that the company is well-positioned to capitalize on its solid financial footing and operational strengths to maintain and hopefully increase existing business, as well as capture business from those competitors that may not be able to survive the turmoil.

HIHO’s move could have legs.  With one of the lowest enterprise value-to-sales ratios in the microcap universe, even a small operational improvement could dramatically effect earnings. 

DISCLOSURE:  Long HIHO.  Also long one worn copy of Highway 61Revisited, and deeply apologetic for the title to this post.

A year or two ago, buying deep value stocks was a pretty easy way to make money with microcaps. Like most microcap traders, I built screens to identify these stocks.  But they no longer work. 

Deep value screens today identify stocks with one foot in the grave, or at least with a set of shareholders ready to unload into any pop.  So I ditched the old screens, and set about developing new new tools to identify microcaps that may be in the early stages of a significant move.  This approach requires use of a technical analysis screener as a first pass, followed by fundamental analysis.

I’ve toyed around with a number of technical screeners, but with the right tweaks none are better for microcaps than MarketClub’s "Smart Scan."  Don’t use the out of the box settings.  The default screen uses an indicator called directional movement index (DMI) that is not  tuned for smaller stocks.

I shift the scan setting to "Chart +100."  This will identify stocks with a perfect +100 score on MarketClub’s objective technical analysis scoring.  To focus in on microcaps, I limit the universe to stocks under $10.

The results of this scan — which I call the Century Club — are almost always worth further investigation.  Keep in mind that the scan is only the first step.  I follow it up with  a look at the fundamentals and news flow.

Each scan pulls up around 50-100 stocks.  Here are a few from a scan I ran at the end of business Tuesday, June 23:

Beacon Enterprise Solutions  (BEAC)

Commercial Vehicle Group (CVGI)

Evolving Systems (EVOL)

Evotec AG (EVTC)

La-Z-Boy (LZB)

DISCLOSURE: No positions in stocks mentioned. Besides being a heavy user of MarketClub’s smart scan, I’m also an affiliate.

When I last wrote about Diedrich Coffee (Nasdaq:DDRX) two years ago, it was a sleepy stock stuck in the $3-$4 range.  Boy have times changed.

After dropping well under $1, Diedrich Coffee has turned into the hottest stock in the nation, shooting up over 2000% to top $18.

Get an updated  DDRX trend analysis or a risk free trial of MarketClub (unlimited live, real-time signals with audio interpretation) courtesy of Ino.

The business has transformed as well.  Diedrich Coffee is selling its remaining Gloria Jean’s stores and will focus now on expanding its manufacturing of K-Cups, the single serving thingies that fit into the Keurig brewing system developed by Green Mountain Roasters (Nasdaq:GMCR).   Diedrich’s Coffee People K-Cups are one of the most popular grocery items on Amazon.com.

Last quarter, the new focus really hit the bottom line.  Diedrich reported earnings of $.25 per share, versus a loss of $.39 in the year-ago quarter. 

While the stock’s quick rise has polarized investors, neither the bulls nor the bears know at this point whether the strong results and operating margins will be sustained.  All eyes will be focused on the company’s next report to see if Diedrich continues to deliver. 

I’m always tempted to short stocks with this large a rise, but I won’t short Diedrich here for four reasons:

1. technically, Diedrich is on fire.  Its very close to new all-time highs and shows no signs that the action over the last week or so was anything more than a pause in the rally.  Its just not safe to short here without an objective sign of weakness.
2. low float.  With a float of only 3.01 million shares, shorts can get squeezed hard. 
3. fundamentally, Diedrich appears to be executing its transformation well.  No reason to believe that this changes over the coming few months.
4. market cap is not that high.  Yes, the rise has been dizzying.  But even now, Diedrich is only worth around $100 million.  Another few good quarters and it could easily grow into its current, or even a higher, valuation. 

Bottom line:  I have no position in Diedrich (DDRX) but will consider playing this from the long side as long as (a) Diedrich maintains technical strength by an objective measure (I use trade triangles but certainly another measure like 50-day MA could be used); and (b) Keurig continues to do well, which I’ll measure by both  Amazon.com sales rankings and Green Mountain Coffee Roasters (GMCR) stock prices.

DISCLOSURE:  No position.