8 Small-Cap Stocks With Big Growth Potential

OLD NAVY SHOPPERS might find $300 blue jeans befuddling. They can get any cut, shade, wash or strategic signs of wear they fancy for $30. The value of super premium jeans, I'm guessing, lies in their ability to signal to peers, generally through a logo on the behind, that the wearer has paid a super premium, and is therefore a person of means and taste. The upstart maker of posh jeans faces a difficult contradiction. Recognition begets sales, but only sales can bring recognition. That makes for an awkward first sales call on a department store, but also for giant, self-perpetuating returns for the rare company that reaches critical mass.

Vernon, Calif.-based True Religion Apparel (TRLG) seems to have pulled it off. Formerly Guru Denim, the company in 2003 was bought by (took over the stock listing of, really) an insolvent Vancouver gold miner named Gusana Explorations. It changed the name to True Religion, its brand of jeans that already sold at the time through Saks Fifth Avenue, Neiman Marcus, Bergdorf Goodman and Urban Outfitters. Sales the following year jumped more than 10-fold to $27 million and True Religion turned its first profit. This year sales are seen hitting $226 million. Shares, which could be had for less than a dollar five years ago, now fetch $28.

True Religion now looks poised to follow the strategy of Guess (GES), whose share price, despite a recent stumble, has multiplied to $35 from $2 over the past decade. The rise has been spurred by Guess opening its own chain of high-margin stores to complement its wholesale business and by its selling more clothes abroad. True Religion had a single store in 2005, but plans to end this year with 30 and next year with 50. It has distributors in 50 countries and is eyeing the U.K. and Japan as promising hosts for retail stores. Also like Guess, the company has extended its brand to more than jeans: T-shirts, button-downs, fleece and so on.

Plenty can go wrong during a young company's growth spurt. Funds can run out. Production can hit bottlenecks. Managers can squander a plump stock price through liberal new-share offerings and options grants. True Religion seems likely to avoid such stumbles for now. It holds $48 million in cash with no debt. Production is outsourced, mostly to nearby manufacturers; 90% of jeans are made in Los Angeles. And founder and Chief Executive Jeff Lubell seems a good steward for the stock, as he owns more than 10% of it.

Growth opportunities abound. International sales, now just 18% of the company's total take, could double by 2010, analysts reckon. Management wants to push licensing fees, collected from companies that use the brand for shoes, handbags, fragrances and the like, to 5% of sales from 1% today. It hopes to increase nondenim sales to between 40% and 50% of sales from 28% today. That would be plenty profitable. True Religion T-shirts, for example, are merely blank shirts bought from abroad with a last-minute design printed on as fashion trends dictate. They sell for $60.

Shares of True Religion go for 18 times this year's earnings forecast, which seems a reasonable price considering the growth. Earnings per share are expected to increase 21% this year and 22% next year — figures that already account for the impact of a sluggish economy on pricey jean sales. The company turned up recently on a Small-Cap Growth screen, which looks for brisk sales and profit increases among companies whose collective share value, or market capitalization, is less than $1 billion. Have a look at seven other screen survivors if you like. Run the search for yourself anytime using SmartMoney's stock screener and the full list of search demands.

Also See: