We've seen strong performance in many stocks in the market over the last two days. Especially strong have been China stocks which moved sharply higher Tuesday on the heels of healthy trade data and robust economic growth expectations. National Bureau of Statistics Chief Economist Yao Jingyuan said China's economic growth would stay above 8% this year, helping to ally fears of a double-dip recession elsewhere around the globe.  

That statement helped to propel many of the China stocks in the Small Cap Investor PRO portfolio sharply higher. And Lotus Pharmaceuticals (OTC BB: LTUS), which I've recommended here in Small Cap Investor Daily, was a top performer,jumping 17% yesterday to close at $1.68.  

I've been hammering home one point lately: The market is paying attention to news again. Be sure to remember this, as volatility has increased with investors moving in and out of equities as new news is released. The volatility is creating great buy and sell opportunities for active traders. It's also presenting opportunities for long-term investors looking to pick up shares in companies they've been watching in anticipation of a pullback.

Stock prices will very likely be more volatile this year than in 2009, and we've already seen this with a pullback in January. That means it's going to be even more important to do your research and buy quality stocks at reasonable valuations. It's also going to be crucial for investors to focus on the sectors that will outperform this year. Of course, all of this will be part of our ongoing conversation here in Small Cap Investor Daily.   

*** I want to briefly discuss three stocks that readers have sent in to have me take a look at. Now, of course we love to receive requests to look at companies that have glowing prospects and stocks trading at dirt-cheap valuations. Those gems we continue to follow because many of you are buying shares. And it's always exciting to track a company as it grows from a micro-cap, to a small-cap, and eventually to a large-cap stock – making investors huge gains along the way.

But some readers are having a good time finding highly speculative stocks that are not yet profitable, and are sending those in. I don't buy shares of these types of companies, but that doesn't mean you can't trade them for quick gains. I limit risk by investing only in companies that have turned the corner of profitability because, if a company can't earn a return on the products and services it sells, I don't want to invest my hard earned dollars. So buy shares in unprofitable companies if you wish, but be aware that these will be among the first, and fastest, to fall when sellers head for the exits on dismal economic news.

*** So let's take a quick look at some stocks that were recently sent in and I'll point out the red flags that jumped out at me. Consider this the small-cap chopping block. While I usually want to tell you what I like to buy, it's occasionally helpful to take a look at what not to buy too. So for readers who sent these in, don't take this personally. I'm simply trying to cover the spectrum of stocks that readers ask me to look at.

First up is Legend International Holdings (OTC BB: LGDI) from William M., a subscriber to Small Cap Investor PRO who favors the company as a play on India and China. Legend is on the chopping block because the Australian based diamond miner and phosphate producer is losing money at an increasing rate each year. Now, that's not surprising for an exploration stage company since it is putting all its resources to work finding and securing properties. But I'd prefer to invest in companies that are in production now. Unless profitability is on the near-term horizon, a milestone I didn't see when evaluating the company, this could be dead money for quite some time.

Similarly, I don't like Lexicon Pharmaceuticals (Nasdaq: LXRX) because it too is loosing more money with every passing year and will not be profitable for the foreseeable future. Reader Jeff G. with ties to Vermont wrote in with this stock.  Sorry Jeff, while I wish I could recommend it, it's on the chopping block instead. Lexicon, like many small-cap biotechnology stocks, is just too speculative. Usually, investors in these types of companies just wait patiently, hoping that their stock will hit it big. Unless you have the time to really specialize in this sector, steer clear. I'd much rather own shares in Lotus Pharmaceuticals then Lexicon.

Now, I don't mean to be harsh by chopping these stocks, but better you hear it in Small Cap Investor Daily then look at your investing account one day and see the painful news there. Keep up the good work by scouring the universe of small-cap stocks, I'm getting better and better submissions every day.    

***This brings us to Bill H. who requested I look at Huston American Energy Group (Nasdaq: HUSA). This is an exploration, production, and development company with a foothold in the natural gas, crude oil, and condensate markets. Now, I think Bill likes this company, and not just because he's been watching it since July when it was a $2.00 stock. Yesterday it closed at $8.11, a nice 305% surge since Bill's been on it.

Huston American Energy Group turned the profitability corner in 2007 when it earned $563,000 on $5 million in revenues. Earnings dipped in 2008, mostly due to some non-recurring charges, but revenue more than doubled to $10.6 million. The company has operations in Texas, Louisiana, and Colombia, South America.

Colombia is a South American country led by President Alvaro Uribe Valez. Despite significant issues with drug trafficking, illegal surveillance, and civil rights injustices, Colombia has seen a huge increase in oil and gas exploration over the last decade. This has been helped by fiscal reforms and by President Uribe's efforts to squash Marxist rebels who had an ugly habit of bombing oil pipelines. It hasn't helped their cause that rebels killed President Uribe's father in 1983. He is now one of the U.S.'s strongest allies in Latin America.     

Naturally you're wondering - will Huston American perform again in 2009? The answer is… sort of. I know, a little anti-climatic, but it's the truth. The company lost $1.48 million in the first quarter of the year and despite making $530,000 in the second and third quarters, it's unlikely to turn a profit this year. The loss in the first quarter was due to a big drop in revenues and analysts are projecting a loss of $0.03 for the year.

But this company has potential and the Colombian and natural gas exposure certainly make Huston American Energy interesting. I'm going to take a closer look at this one and will let you know if I think it's worth your attention in the future. For now, it's not on the chopping block, and congrats to Bill if he rode the stock for the 305% gain since June.  

***Let's keep in mind that the markets had a heck of a run in 2009, and big gains in 2010 will be a bit harder to find. This means we really need to find outstanding companies that are growing profits. I firmly believe the more speculative, lower quality companies that have yet to earn a profit will see their shares under-perform in 2010. With this in mind, be careful when you purchase shares of companies like the two on the small-cap chopping block. While these may hold profit opportunities for short-term traders, I want you to invest in companies with profitable business models.

If you would like to learn more about the companies I recommend, I encourage you to begin a trial subscription to Small Cap Investor PRO. You can likely cover the cost of a yearly subscription within just a few weeks of investing in my favorite stocks. Plus there is absolutely no risk when you sign up for a trial subscription. Just click here to find out more about how you can get started with Small Cap Investor PRO today.

Keep sending me your ideas, my address is editorial@smallcapinvestor.com. I'll give you my thoughts in a future issue.