[Editor’s note: “10 Small-Cap Stocks to Buy Before They Grow Up” was previously published in July 2019. It has since been updated to include the most relevant information available.]
One of the themes of this bull market has been that the best stocks to buy haven’t been value plays — and they haven’t been small-cap stocks, either. Big growth names have outperformed; smaller stocks generally have not.
Indeed, as the Wall Street Journal noted last month, small-cap stocks had underperformed large-caps by a full 15 percentage points over the previous year. Why exactly that is remains up for debate. Size may be a greater asset in the modern business world — particularly in tech. Or as some fear, the lack of enthusiasm toward small caps suggests worries about the near-term fate of the U.S. economy.
Whatever the case, in a market that lacks bargains, the small-cap stocks space offers a few. These ten stocks to buy fit the traditional definition of small-cap stock with a market capitalization of $2 billion or less. All 10 have plenty of reasons to see those market capitalizations moving higher.
Turtle Beach (HEAR)
Gaming headset manufacturer Turtle Beach (NASDAQ:HEAR) has offered one of the more incredible rides of any stock in the market over the past few years. On a split-adjusted basis, the stock went from $80+ in 2013 to $2+ by early 2018. The numbers are ‘split-adjusted’ because Turtle Beach had to execute a reverse split in April of 2018 just to get its stock price above $1, and keep its NASDAQ listing. Bankruptcy seemed possible, if not likely.
After all, bears argued, Fortnite was supplying a short-term boost in demand. Turtle Beach’s growth would reverse in 2019. That’s exactly what happened — and HEAR stock headed back to the single digits.
But HEAR stock has rallied of late, and there should be more ahead. 2019 results are headed down, but that doesn’t doom the company. The company still should be able to grow going forward, with many of the headsets sold in 2018 likely to be replaced in 2020 and 2021. Meanwhile, gaming-related stocks like Nvidia (NASDAQ:NVDA) and Logitech (NASDAQ:LOGI) are getting premium multiples, but HEAR stock remains cheap.
Long story short, HEAR should have pulled back from $30+, but a decline to $8.80 looks like too much. And investors willing to use options can sell puts (as I have) to capitalize on still-high short interest in this small cap stock.
Tivity Health (TVTY)
In the past two years, shares of small-cap stock Tivity Health (NASDAQ:TVTY) have plunged twice. TVTY stock fell 32% back in November 2017, when UnitedHealth Group (NYSE:UNH) announced it would provide a fitness benefit to Medicare Advantage members. That benefit competed with Tivity’s Silver Sneakers program, which provides free gym visits for senior citizens under Medicare and private plans.
TVTY stock dropped about the same, on a percentage basis, in December of last year, when the company acquired Nutrisystem. And the two plunges, about thirteen months apart, highlight the two key risks to Tivity Health stock.
First, can the company survive in a healthcare space increasingly populated by giants? And, second, was the Nutrisystem deal a bad move? After all, Nutrisystem already had started struggling before Tivity acquired it.
With TVTY down close to 60% from December highs, both risks look priced in. Silver Sneakers and the company’s other programs are growing. And Nutrisystem was attractive enough as a business that I owned the shares ahead of the acquisition even with a slowdown. The combined company can offer real value to health care payors — and to end customers. At this point, even if Tivity did overpay, it’s lost about $1 billion in market capitalization — getting close to equal to what it paid for Nutrisystem.
That’s not to say the risks aren’t real. But at 7.5x forward earnings, TVTY looks like not just a high-risk play, but a high-reward one as well.
Century Casinos (CNTY)
The worry with Century Casinos (NASDAQ:CNTY) might be that at least a few investors already have figured out the story here. Century historically has been a sleepy stock, albeit one that has generated solid returns since the financial crisis. A lack of focus — the company has operations in Poland and several Canadian markets, along with a now-smaller business running cruise ship casinos — and a small size gave CNTY of a “best kept secret” kind of feel.
But a recent deal with Eldorado Resorts (NASDAQ:ERI) changes that case and led CNTY to sky 12%. Century is picking up three U.S. casinos while leasing the assets to REIT VICI Properties (NYSE:VICI). 96% of profits now come from North America, and Century got a great price, as Eldorado needed to divest the properties ahead of its planned merger with Caesars Entertainment (NASDAQ:CZR).
That said, there’s still a nice story, even if CNTY already has run up (gaining 30% so far this year). There are other small- to mid-sized properties Century can target if it wants to replicate Eldorado’s successful growth-by-acquisition strategy. The balance sheet, even after the acquisitions, remains in good shape. Earnings are growing despite macroeconomic weakness in western Canada. And the small-cap stock, on a peer basis, remains cheap. There could — and probably should — be more upside ahead.
Kulicke & Soffa (KLIC)
At first glance, semiconductor equipment manufacturer Kulicke & Soffa (NASDAQ:KLIC) looks like an awful stock — even for a small-cap play. Sales in the first half of fiscal 2019 declined 37%. Analysts expect EPS this year of just 23 cents- against $2.43 the year before.
But Kulicke & Soffa is a semiconductor equipment manufacturer. That’s a brutally cyclical industry, which explains why revenue has pulled back amid uneven chip demand. And the company has nearly $10 per share in cash on the balance sheet, which means its ‘true’ earnings estimates are much lower.
Indeed, analysts are looking for a rebound in FY20 EPS to $1.50, albeit with a wide range. Should those fiscal 2020 earnings estimates be roughly in line, KLIC has a very attractive multiple. And the long-term trends favoring semiconductor stocks — 5G, IoT, autonomous driving, etc. — all can help demand for Kulicke & Soffa products, even if that demand likely will stay choppy.
In a market where chip names have rallied of late, including larger semicaps like Applied Materials (NASDAQ:AMAT) and Lam Research (NASDAQ:LRCX), KLIC has somewhat underperformed. Assuming demand bounces back — and it should — that will change in the coming quarters.
Cannae Holdings (CNNE)
There are two aspects to the Cannae Holdings (NYSE:CNNE) bull case. The first is an attractive ‘sum of the parts’ argument. Cannae holds a stake in Ceridian HCM Holdings (NYSE:CDAY), which it is slowly divesting. Cannae also holds leveraged equity in Dun & Bradstreet, which it helped take private last year, along with other assets including restaurant chains. (Those chains, including O’Charley’s and Village Square, have been the most disappointing part of the business so far.)
On paper, then, CNNE has upside. But the second part of the bull case is that in practice, the cash coming from sales of Ceridian stock are going to a management team that has created huge shareholder value in past efforts. Cannae comes from the Fidelity National Financial (NYSE:FNF) tree, whose chairman Bill Foley has proven to be a masterful allocator of capital. Investors in CNNE basically are getting an opportunity to invest alongside Foley and his management team at a discount. Opportunities don’t get much better than that.
SailPoint Technologies (SAIL)
SailPoint Technologies (NYSE:SAIL) stumbled badly after its Q1 report in May. SAIL stock fell nearly 30% following a full-year guidance cut. But the shares climbed after the company reported stronger-than-expected Q2 results last month.
SailPoint provides identity management software for businesses — a space with obvious demand growth.
The story here is dented but not broken. And with many software plays trading at nosebleed valuations — including peer Okta (NASDAQ:OKTA), which is valued at almost 30x sales — that could provide an opportunity. If SailPoint can right its ship (pardon the pun), there’s room for huge gains.
Boise Cascade (BCC)
There’s a lot to like when it comes to Boise Cascade (NYSE:BCC). BCC stock is reasonably cheap, at a likely low double-digit multiple to 2019 adjusted EPS. The lumber producer is shifting its strategy, focusing on engineering wood in its Wood Products division and aiming to grow market share on the distribution side. That could drive growth and margin expansion going forward — neither of which look priced into BCC right now.
There are some risks. Debt is a modest concern, although manageable. The same is true of the company’s pension expense, though the company moved ~60% of participants off its books last year. From an industry standpoint, the construction cycle needs to stay strong, and there is no shortage of housing-related stocks at similarly cheap multiples right now.
Still, there’s a nice under-the-radar story here — and a nice combination of value and growth potential.
The case for PetIQ (NASDAQ:PETQ) is much the same as it is other for other pet-centric plays. Americans, in particular, are spending more money on more pets every year. And so Chewy (NYSE:CHWY) has a market cap of $12 billion, and General Mills (NYSE:GIS) acquired Blue Buffalo for $8 billion. There is real growth in the U.S. pet market.
PetIQ has two primary ways to play that growth. Its growing network of veterinary offices targets the services side. It sells products under national brands as well, including prescriptions. The latter category should be boosted by the $185 million acquisition of the animal services business of Perrigo (NYSE:PRGO).
PetIQ has seen some choppy trading, and choppy performance, since its IPO in 2017. But the company, and the stock look to be back on track. Merck (NYSE:MRK) reportedly is considering an acquisition in the category, and PetIQ could be a target. On its own, market gains, the Perrigo acquisition, and share increases should allow the company to grow into a reasonable, if somewhat steep, ~22x forward P/E multiple.
Either way, both investors and acquirers have shown they’ll pay up to enter the pet market and PETQ might be the most attractive play in it right now.
Opera Limited (OPRA)
Small-cap stock Opera Limited (NASDAQ:OPRA) has an interesting story and a reasonable valuation. The Norwegian company provides web browsers — both PC and mobile — overseas, with over 350 million users. It’s adding a fintech business — including a microlending effort — while looking to drive growth in developing markets in Africa and Asia.
Those growth efforts are hitting profits this year – but OPRA stock still is reasonably cheap. The company has no debt, which de-risks the story somewhat.
To be sure, there’s still risk. Competition from the likes of Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) and Microsoft (NASDAQ:MSFT) will remain intense. Developing markets raise macro exposure: advertisers may pull back on spending if domestic economies weaken. Even a stronger dollar could hit reported profits and value for U.S. investors.
But in a market where seemingly every growth story is priced at a premium, Opera has an interesting story of its own. And the valuation is such that if that story plays out, the upside could be tremendous.
Progress Software (PRGS)
Another software stock with an intriguing growth and value combination is Progress Software (NASDAQ:PRGS). Top-line growth for Progress has stalled out in recent years, but a 10% constant-currency increase in the fiscal second quarter suggests brighter days may be ahead. PRGS has jumped after its last two reports, including a huge gain after Q1 (thanks to second quarter guidance), but a recent pullback brings the price back into value territory. PRGS trades at less than 14x next year’s earnings.
On this site last month, Will Healy named PRGS one of 3 software stocks to buy. As Healy noted, Progress could be an acquisition target, particularly once it integrates its recent purchase of privately held Ipswitch. If fiscal 2019 results are any indication, PRGS should rally, whether on a buyout offer or on its own.
As of this writing, Vince Martin is short puts in Turtle Beach and long shares of Cannae Holdings. He has no positions in any other securities mentioned.
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