I can't speak first hand (yet....), but I attended a small liberal arts college (1,000 students) with a physics department that consisted of two professors. There was research in X-ray crystallography, plus whatever the senior students were doing for their thesis. I know several stories of physics graduates going on to graduate school, and doing very well.
One example, my friend graduated in 2002 and went to Oregon State U (one of the few places at which both him and his girlfriend were accepted) and is getting his PhD in Nuclear physics. He may have it by now, I've lost contact with him.
I remember him saying that many people were suspicious of the undergraduate preparation that he would have from a small liberal arts school, especially trying to continue on for a PhD in physics, but he found the opposite to be true. He felt more prepared then the average graduate student.