At first glance, many small caps may seem expensive. That's because they are. You don't own stocks for where they've been though.... you own them for where they're going. In that light, small caps may well justify their lofty valuations. We'll break it down below, sector-by-sector.  First though, let's recap this week's highlights from the community. On tap are opinions of China Security & Surveillance Technology (CSR), Trico Marine Services (TRMA), AVANIR Pharmaceuticals (AVNR), United Community Banks (UCBI), and Cardinal Health (CAH). .   Stocks In Focus Why These Stocks Appear on Buy Side Lists: AVNR, VICL, ENTR  Whatever AVANIR Pharmaceuticals (NASDAQ:AVNR) is doing, it's the right thing, and the company needs to keep doing more of it - investors are pushing AVNR upward in a hurry. Actually, as Dennis Askew points out, it's got a lot to do with the AVANIR's Zenvia drug and the FDA. Check it out.  At Their Tipping Points - Outlooks for CHIO, CAH, and SLTM James Brumley pointed out yesterday that Cardinal Health, Inc. (NYSE:CAH) was at a technical bearish tipping point; the stock wasted no time today making good on that prognosis. Where will Cardinal Health land, and what were the warning signs? Check it out.  What These Stocks Are Doing Perfectly Right: DDIC, GSIT, UCBI Speaking of doing things right, United Community Banks, Inc. (NASDAQ:UCBI) has been doing just that for a while as well. What was that specifically? Avoiding bad loans. While the initial shock of the loan and real estate crisis is now only a memory, foreclosures are still increasing. Where does United Community Banks stand on that front? Find out.  Turning the Corner? Reviews of LLNW, TRMA, and CSUN Trico Marine Services Inc (NASDAQ:TRMA) did it! A chart analysis posted yesterday posed Trico Marine Services as a strong breakout candidate, and TRMA managed to clear its last hurdle today. Now that the path is clear, look for more upside. Be sure to check out the full commentary though, as it explains how the stock was launched.  CSR: Watch out for the Watchers Looking for an honest, unbiased look at a stock? Check out Ken Tudor's assessment of China Security & Surveillance Technology, Inc. (NYSE:CSR). The good and the bad are laid out in plain English - a breath of fresh air in an arena that thrives on hype and denial of the obvious.    High Growth Versus High Prices - What's 'Worth It'? Hang onto your hats, folks - this week's edition is little heavier-duty than usual. It's worth it though, as it could give us a serious edge concerning the stocks we pick over the course of 2010.  What's so special about this discussion? I'm going to be giving you some valuations and growth measures specifically for the small caps (S&P 600 stocks) on a sector-by-sector basis. Trust me.... you won't be getting this data in too many other places. (The fact that I had to do most of this math by hand should tell you how unavailable it is.)  What's the point? It's simple really - information is power. These P/E ratios and PEG ratios will give you decision-making information that few others have. As such, you'll be able to make better investing decisions than the investors you're competing with.  First thing first though ....a reality check.  Apples to Apples  As small cap enthusiasts, we should go ahead and accept the fact that we're going to pay higher prices for our stocks. In plain terms, the P/E ratios we're going to face will generally be higher than those of comparable large caps stocks. That's not the whole story though.  While our 'P' may be bigger, our 'E' can grow much faster than the 'E' of most large cap stocks. So, to fairly judge the merits of a small cap's potential, we really need to be looking at PEG ratios, which compare P/E ratios to earnings growth rates.  And, that's part of what we're going to be doing below... making sure we're not jumping to conclusions simply because a sector 'looks' expensive based on a P/E measure alone.  P/E Ratios, Past and Future  It's somewhat misleading to use 2009's full-year price/earnings ratios, as losses taken in the early part of last year have skewed the data somewhat. With no alternative though, we'll go ahead and do it; the forward-looking P/E ratios are the focal points anyway.  And what do we see? No real surprises... the average small cap was very expensive then, and less expensive now. Still, with projected earnings multiples hovering around 21 (based on 2010's estimates), it's not like small caps are cheap at this point.  Scary? In some cases, yes. Let's round out the perspective though, by factoring in actual earnings growth rates.  Earnings Growth  Bear in mind that the bulk of the expected earnings growth from these stocks in 2010 is based on Standard & Poor's estimates rather than actual numbers. So, we have to take a leap of faith that their analysts are at least close to being on target. I wouldn't bet the farm on their projections, but I'm comfortable enough with their outlooks for the purpose of this analysis.  In any case, the 2010 and 2011 earnings per share growth rates (full-year basis) are on the nearby table.  It kind of changes the perspective on the high P/E ratios, doesn't it? Granted, some of the growth percentages are pumped up more because of a terrible 2009 than a fantastic 2010, but growth is still growth. By 2011 though - which will be compared to 2010's numbers - growth rates will be back to normal and more meaningful levels. (Of course, 2011's forecasts are also fuzzier guesses.)  Do you see the problem? The P/E levels are high, but so too is earnings growth. How do you sort it out? That's what a PEG ratio does - compares a P/E ratio to an earnings growth rate. When put in this light, you can really start to make meaningful comparisons of the price you're really paying for profit growth.  Grand Finale  So let's bring it all home now, and make those PEG comparisons in addition to making a couple of points.  The nearby table tells the tale very succinctly. Using earnings for the trailing twelve months and yesterday's stock prices for my 2010 P/E ratios (I had to accept S&P's 2011 forecast of P/E ratios), and using 2010 and 2011 earnings growth rates as the 'G', I've projected 2010 and 2011 PEG ratios.  As I already said, the earnings estimates themselves aren't something we should have perfect blind faith in, but even if S&P's people are only half right, wow..... serious values.  [One caveat: In general, you would compare a historical growth rate to a historical P/E. For this analysis though, I compared a historical P/E to a projected growth rate. Though not ideal, it's all we've got in terms of making a reasonable assessment as to the future value of these small caps.]  A couple of numbers are worth highlighting, like technology's and healthcare's.  If the 'small cap technology' thing rings a bell, it's because that's the same point - but for a different reason - I made two weeks ago in the 'Time to Downside Hardware Stocks' edition. It's a total coincidence, but not a surprising one.... charts and fundamentals tend to line up quite nicely when given enough time. There's a time limit on this tech opportunity, however.  On the flipside, small cap healthcare is still stunningly expensive, and not even close to being justified by earnings growth. That's expected to change somewhat in 2011, though I have to question that optimism based on 2009's and 2010's actual healthcare numbers. The federal healthcare overhaul only enhanced the earnings challenge here. As for everything else, just keep two things in the back of your mind.  The first is the PEG rule of thumb - anything below 1.0 is 'cheap', and anything above 1.0 is 'expensive'. The smaller the company though, the blurrier that line gets. Still, we can use these PEG figures to make comparisons to other sectors in the same market caps group, or to other sized stocks in the same sector.  The second take-away... all of this information only matters if these small caps can actually grow earnings at the expected rates. And, only time will really tell if that's possible. The fact that so many of these small cap sectors are sporting PEG numbers well under 1.0, however, tells me there's some serious doubt about the forested earnings growth. So, you may want to make a mental adjustment and consider something under 1.0 as a 'norm' for the time being.  Personally, I expect to see some of these sectors hit these EPS targets, and some not. While I too have my doubts that we'll see such huge overall earnings growth, even at half these anticipated growth rates for some sectors, I'd still be satisfied.  Either way, you've now got a comparison framework and benchmarks to work with, which is the big value of this analysis.  I'll update this data when there are any significant changes. .        We Value Your Feedback Got comments, questions or suggestions? 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