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Markets

6 Small Stocks Poised for Big Gains

They're riskier than blue chips, but they offer greater rewards.

One irony of investing is that you can reap some of the biggest gains when economic pain is most severe. The market looks ahead, with small-company stocks often leading their blue-chip brethren toward better days. Since the 1930s, small-capitalization stocks have gained an average of 44% in years when economic growth has ranged from flat to down 2%. We think the economy will shrink by 2% in 2009, with a tepid recovery starting in the fourth quarter. So go ahead, sample some small caps, which we define as companies with market values of less than $2 billion. For now, stick with high-quality companies that have little debt or resilient revenues, or offer a product or service that helps customers wring efficiencies from this do-more-with-less economy.

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Tough times have created a trade-down lifestyle. So as fewer people buy cars, more will have to fix their old ones. But where? Almost 1,000 auto dealers closed in 2008; even more are expected to do so this year. That leaves neighborhood garages, where there are no guarantees, or national chains, such as Monro Muffler Brake (symbol MNRO). Monro operates 734 company-owned stores nationwide. And, boy, are they busy. For its fiscal third quarter, which ended December 27, 2008, Monro reported that earnings per share increased 12% from the same period a year earlier, on a 6% rise in sales. (All share prices are as of the close on February 6.)

The $3-billion-a-year hazardous-waste disposal industry brings relatively stable revenues. Meanwhile, onerous regulations have shrunk the number of competitors over the past three decades from 20 to five. No new hazardous-waste landfills or incinerators have been built in more than a decade. Clean Harbors (CLH), with some 45,000 customers, claims 65% of domestic incinerator capacity, 23% of landfill volume and pricing power commensurate with that preeminence. Increased government spending on cleanup will likely offset production slowdowns among chemical manufacturers, which are big customers of Clean Harbors.

K12 (LRN) offers online curricula to students in kindergarten through 12th grade, most of them enrolled in RvirtualS public schools in 21 states and Washington, D.C. K12 caters to students who might be learning more quickly or more slowly than their counterparts in red-brick schoolhouses. Or they may live in neighborhoods with subpar or unsafe schools. Relative to other for-profit education stocks, shares of K12 have performed poorly because of concerns about the financial health of state and local governments. But K12 is an attractive option for underfunded school districts; its virtual chalkboard can cost 40% less than a traditional one.

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An offshoot of accounting firm Deloitte & Touche, Resource Connection (RECN) provides project-by-project consulting in finance and accounting. Call it a high-caliber temp service that can help iron out wrinkles in a supply chain or finesse a financial restatement. Its temps are experts, paid by the hour, who prefer a flexible arrangement -- a business model that allows the firm to limit expenses when work is scarce. Expect earnings to slump as long as the economy does. But the bulls say the stock is too cheap to pass up. By some measures -- price in relation to sales, for instance -- it sells below where it stood in 2002, when it fetched less than $7.

Investors seeking hot-button businesses with hot prospects need look no further than Tetra Tech (TTEK), an engineering consultant with operations in water infrastructure, environmental cleanup and wind power. Tetra could land the lion's share of the government's economic-stimulus funding for water projects. Its highly complex environmental work -- restoring the Everglades, for example -- tends to withstand economic swings. With Tetra's clean balance sheet and strong cash flows, its stock deserves a premium price-earnings ratio compared with its peers -- 18 times estimated 2009 earnings, versus an average of 13 for the group.

When retailers are struggling, children's retailers tend to struggle less because parents are willing to give the shirt off their own back to put a nice one on Junior's. And Gymboree (GYMB), which makes and sells apparel for the sandbox set, is in better shape than most to wait out the doldrums and resume growth after the recovery. It has three retail chains under its umbrella that target value-conscious to high-end customers. Gymboree will defend profit margins this year with pay cuts for staffers and executives. The company has no long-term debt, and its stock trades at ten times estimated earnings for the year that ends next January.