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This Small Cap Could Rocket 60% Higher by Mid-2014

Melvin Pasternak

I'm a big fan of buying stocks that have recently hit a new all-time high. Clearly they have strong momentum, but the main reason is that, because there is no overhead resistance, they often go higher.

And when that bullish chart is supported by a strong fundamental story, combined with a small, but steady dividend, the stock is often a winner. One stock that meets these criteria is small-cap Methode Electronics (MEI), which manufactures component devices for original equipment manufacturers, including electronic, sensing and optical technologies.

With a market cap of just over $1 billion, this global manufacturer's main business segments are automotive, interconnect and power products. Automotive -- its largest segment -- currently accounts for about 60% of the company's revenue. This division supplies electronic and electromechanical devices and sensors to companies like Ford (NYSE: F) and General Motors (GM).

Ford uses Methode's TouchSensor consoles for its MyFord driver connect console, a touch-screen dashboard-like console, which enables drivers to integrate their mobile phones and digital media players while driving. General Motors also uses a similar console design, termed the K2XX, in its SUVs and trucks.

In the most recently reported fiscal first quarter of 2014, console sales to Ford and GM helped bring Methode's total revenue to $167.3 million, a 41% increase from the year-earlier period. Net income ballooned nearly 250% from the year-earlier quarter to $13.8 million.

Better-than-expected console sales to General Motors and new European automotive products, as well as increased sales in the interconnect and power products segments, are expected to drive future growth.

The technical picture for MEI is strong.

MEI Stock Chart

Rising off a low under $7 in May 2012, shares formed a major uptrend and are up more than 300% to date.

In February, shares catapulted nearly 20% in a single week -- from about $10 to $12 -- marking the start of an accelerated uptrend. Continuing its steady ascent, MEI broke above historical resistance, near $12, dating back to late 2010.

Upon breaking this resistance, the 50-day moving average bullishly crossed above the 200-day moving average, a highly bullish technical formation known as a "golden cross." Since the golden cross occurred, shares have more than doubled in value, rallying from about $13 to a high above $28.

In late August, MEI rose several dollars in anticipation of strong fiscal first-quarter results. A better-than-expected report caused the sharp rally to continue. On Sept. 25, MEI made a new all-time high at $28.32. With no overhead resistance in sight, the stock could move much higher.

In my mind, it wouldn't be unreasonable for shares to hit the $45 range within a year. At current levels, this target represents potential returns of over 60%.

The optimistic technical picture is supported by solid fundamentals. Over the past four quarters, Methode beat earnings estimates by an average of nearly 125%. Consistently solid results prompted management to upwardly revise its revenue and earnings expectations for the upcoming fiscal second quarter.

For the second quarter, analysts project revenue will rise 30% to $168.8 million from $129.8 million in the comparable year-earlier quarter.

With the expectation that product demand will continue to increase in all segments, management raised its full-year 2014 guidance to the range of $670 million to $700 million, a roughly 30% increase from $519.8 million last fiscal year.

The earnings outlook is also strong. For the fiscal second quarter, analysts expect earnings to increase 169% to $0.35 per share compared to $0.13 in the same quarter a year ago.

For the full 2014 fiscal year, management anticipates favorable raw material costs, combined with strong sales across its four major market segments, will contribute to a solid earnings gain. The company recently raised its guidance to the range of $1.40 to $1.60 per share, a 150%-plus rise from earnings of $0.56 a year ago.

Methode pays a small quarterly dividend of $0.07 per share, for a current yield of 1%. 

Risks to consider: Methode's strong growth outlook is, in part, based on strong performance expectations from new automotive consoles. However, if the economy weakens, so too could demand for cars, potentially causing a decrease in orders for Methode's products. However, the company is well diversified and could weather a mild economic downturn.

Recommended Trade Setup:

-- Buy MEI at the market price
-- Set stop-loss at $16.99, below support marked by the intersection of the accelerated uptrend line and the August low
-- Set initial price target at $43.99 for a potential 59% gain by mid-2014

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