small-capsThis has been one of the best earnings seasons in three years.

In fact, if we exclude the financial sector, earnings growth hasn’t been this high since the third quarter of 2011. According to data from FactSet though last Friday, the blended earnings growth rate excluding financial is an impressive 8.5%.

As always, I’ve been following earnings closely. Two stocks jumped off the page for me last week — not just because they are interesting companies, but also because they rallied 10% or more after reporting.

Given that both are small caps, a 10% post-earnings rally can often be a sign of good things to come. So I thought I’d share a few details on these companies with you (as a side note, I should also mention that both of these stocks are holdings in the 100% Letter portfolio, which is beating the Russell 2000 by over 30% so far this year).

The two stocks are Tyler Technologies (NYSE:TYL) and Datawatch (Nasdaq:DWCH). After reporting, Tyler Tech rallied 10% while Datawatch jumped 14%.

It was the second quarter in a row that Tyler Tech crushed expectations. The $3 billion company supplies information technology for public institutions, most notably local and state governments, schools, courts, cities and counties. Tyler Tech provides the software, hardware, data conversion and training to bring these organizations up to speed, and keep them running smoothly.

Growth is accelerating, an impressive feat given Tyler Tech’s steady growth over the last three years. This chart of annual revenue shows the trend.

small-caps

In the first quarter of 2014, revenues were up 18% and net income was up 40%. But in the just-reported second quarter, revenue growth accelerated to 21% and earnings growth accelerated to 63%.

The business is now generating revenue of $124 million per quarter and EPS of $0.42 – a full $0.07 above expectations. Based on these results, management has increased revenue growth guidance to 16% for the year. And even better, they’ve raised guidance on earnings by 10%, too.

This business is firing on all cylinders and all the catalysts I expected to work are cranking along. Tyler Tech is signing more contracts for its case management software in California, and across all product categories recurring revenue is kicking in.

I fully expect this stock will rally in the coming months and recommend averaging into a position to hold for the long term. The company has a durable subscription-based business model, and high institutional ownership – two qualities that I like in a small cap.

Datawatch is a different type of company – a microcap valued at only $146 million. After a horrid April, a double-digit rally in the stock was well earned by faithful shareholders.

In April, Datawatch reported that Q2 revenue growth would be 14% to 17%. It also reported that an executive left the firm. That disappointing news cut the share price in half and raised serious doubts about the company’s future in the competitive “big data” space.

Last week, Datawatch reported third-quarter revenue growth of 18% to $9.23 million, a record high for this tiny microcap. The mood is definitely better then it was in April and May. But there’s a lot to accomplish, still.

More partnerships are in the pipeline. It has Informatica (NASDAQ:INFA) as a partner now, along with IBM (NYSE:IBM) and (NYSE:EMC).

Datawatch is a long-term play and I recommend it as a “buy and hold forever” stock. Week-to-week and month-to-month, shares of this company can be extremely volatile.

But in my book, what matters most is where it will be in a decade. If you can accept the risk and hold on for that long, I expect a modest investment in Datawatch will pay off.

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Published by Wyatt Investment Research at