Want to know the biggest small cap stock turnaround story of the last six months? Auto parts and homebuilding are good guesses, but the honor actually goes to…. home entertainment software. The S&P Small Cap Home Entertainment Index is one of the biggest losers over the last six months, but also happens to be one of the biggest winners over the last two weeks (and boasts the biggest positive difference between the two timeframes among all small cap groups).

And here’s the more amazing part - much of that turnaround was logged on Tuesday in the shadow of a massive selloff from Electronic Arts Inc. (ERTS) (-9.0%) and ancillary selling from Konami Corp. (KNM) and Activision Blizzard, Inc. (ATVI). In comparison, the Small Cap Gaming Index rallied 1.85%.

In short, the worry that hammered the big guys in the group clearly didn’t reach the little guys. As such, those smaller names may well be unsung opportunities. Let’s take a look.

A Fundamental View

It comes as no surprise (or it shouldn’t anyway) that the nature of these smaller game-makers means earnings will be hit and miss, and some of them will look ugly at first glance - they’re small, and some are new/upstarts. We only say that so you’re not alarmed by the red flags on the valuation grid below.

While the group as a whole has some chinks in the armor, we’re not required to buy the whole group - we just wanted to determine what it was about some of these stocks that made the group able to do something Electronic Arts Inc., Konami Corp., and Activision Blizzard couldn’t do….  which is to not fall.

Now that we’ve got the matrix in front of us it’s pretty clear where the values are.

Changyou.com Ltd. (CYOU) is knocking it out of the park. This Chinese gaming company may well be underestimated in terms of a forward-looking EPS. The company earned more (operating) per share over the last twelve months than it’s expected to this year or next…. which seems a tad odd. Perhaps the updated estimates are just delayed. Either way, you should know Changyou.com Ltd. has met or beat estimates in its past for quarters.

The other stock of interest is Majesco Entertainment Co. (COOL)... a player that has broken into the gaming biz not by writing console or desktop game software, but by creating games for mobile devices.

If this year’s and next year’s EPS targets are met, then yes, COOL is a bargain. You should know, however, that Majesco has fallen well short of estimates - and into the red - in its last two quarters. Still, it’s worth watching.

Take-Two Interactive Software Inc. (TTWO) and THQ Inc. (THQI) both appear to have compelling futures, and may well earn an ‘investment caliber’ rating from us in the future. Earnings have been a little bit erratic though, and have been over and under analysts’ guesses. Before jumping in, we’d like to see a little more certainty or consistency.

Of the two though, THQ Inc. (THQI) is apt to stabilize first.

A Technical View

For what it’s worth, we found this trend/disparity on Tuesday because of the strength of the S&P Small Cap Home Entertainment Index versus the weakness of the large cap version of the same. That’s not necessarily the best index to use though, as it contains a lot of non-gaming companies.

We’ve shown that chart below all the same, but to better monitor the actual small cap gaming stocks as a group, we’re initiating the MicroCapPress Small/Micro Cap Gaming Software Index. The index will include equal weights of all the stocks above, with the exception of pink sheet equity Convera Corporation (CNVR.PK). We’ll update the index constantly, and let you know of key changes when merited.

For today, we’ll simply point out that the MicroCapPress Small/Micro Cap Gaming Software Index is on the verge of breaking above a key resistance line (though the S&P index is as well). The missing ingredient so far is volume, but a few more days of surprising strength from these smaller gaming names will draw out the buyers.

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