MTS SYSTEMS CORP. (Nasdaq symbol MTSC; www.mts.com) makes equipment and software that manufacturers use to test the behaviour of materials, machines and structures. This helps its clients reduce errors and costs.

This business supplies about 80% of MTS’s total revenue and profit. MTS also makes industrial sensors that monitor and control the performance of a manufacturer’s automated machinery.

The uncertain economy is prompting manufacturers to hold off on buying the company’s gear. In its fiscal 2013 third quarter, which ended June 29, 2013, MTS’s revenue fell 4.7%, to $135.1 million from $141.7 million a year earlier.

Sales of testing equipment, which accounted for 82% of MTS’s total sales, declined 5.1%. Revenue at the sensors division (18% of sales) fell 2.7%.

Earnings declined 33.5%, to $11.5 million, or $0.72 a share. A year earlier, MTS earned $17.4 million, or $1.07. The year-earlier results exclude a $7.75-million charge to settle a dispute that kept the company from bidding on U.S. government contracts.

Small cap stocks: Rising car sales prompt automakers to spend more on testing systems

Increasingly strict car emission and safety regulations are also fuelling MTS’s sales. Rising car sales have prompted automakers to spend more on testing systems in order to develop and test new materials.

MTS is also expanding into new fields, such as testing systems for medical device makers. For example, manufacturers use MTS’s motion simulators to make artificial hips, knees and other implants more durable.

As well, demand for MTS Systems’ testing equipment should rise as emerging market manufacturers grow more sophisticated.

The stock has gained 15% in the past year. The company has no long-term debt and holds cash of $53.6 million, or $3.43 a share. Its $1.20-a-share dividend yields 1.9%.

In the latest edition of Wall Street Stock Forecaster, we examine whether the company is likely to use its cash reserves to buy back shares and raise its dividend. We conclude with our clear buy-hold-sell advice on the stock.

(Note: If you are a current subscriber to Wall Street Stock Forecaster, please click here to view Pat’s recommendation. Be sure to log in first.)

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MTS rose 15% this year, despite a drop in its revenues and earnings. With small cap stocks you have owned, have you sold when sales and earnings fell? Or have you tried to look deeper for a reason to hang on or buy more? Can you tell us about a time when you held on to your shares despite an earnings decline, and were rewarded with a rise in the stock’s price?