Small-cap stocks have taken some serious punishment in 2020. The S&P SmallCap 600 Index is sporting a year-to-date total return of -11.8%, well short of the S&P 500’s total YTD return of 3.0%.
Small-cap portfolio managers, especially those that lean heavily on value, are chomping at the bit, waiting for the next leg up. Technical analyst Jonathan Krinsky believes that outperformance could come as soon as this month.
“They’ve gone nowhere for two weeks. They’ve gone nowhere, really, for two years, and there’s a lot of actually technology and high-beta names in there that I think can work,” Krinsky said August 3 on CNBC’s Halftime Report show. “I think small caps are an obvious rotation beneficiary as we push into August.”
We’ve seen a lot of chatter recently about a few stocks driving the markets — five big tech stocks account for 22% of the S&P 500, the highest concentration in the history of the index — so, it seems like a good time to go contrarian.
Here are 10 small-cap stocks likely to become large caps:
iRhythm Technologies (NASDAQ:IRTC)
Alarm.com Holdings (NASDAQ:ALRM)
Goosehead Insurance (NASDAQ:GSHD)
Newmark Group (NASDAQ:NMRK)
Fox Factory Holding (NASDAQ:FOXF)
Howard Hughes (NYSE:HHC)
Stag Industrial (NYSE:STAG)
If you think the big tech stocks are ready for a breather, these 10 small-cap stocks ought to be up for consideration.
Small-Cap Stocks to Buy: iRhythm Technologies (IRTC)
Investors in iRhythm Technologies, the maker of the Zio wearable heart monitor, got an early Christmas present on August 4 when the Centers for Medicare and Medicaid Services (CMS) proposed new, permanent codes for long-term electrocardiogram (EKG) monitoring.
While I wouldn’t consider myself anywhere near an expert about the healthcare system, I can see when a change has been made that is positive for a company’s growth; With permanent, rather than temporary, codes for reimbursement on its heart-monitoring patches, sales ought to accelerate.
Kudos to InvestorPlace contributor Aaron Levitt for recommending IRTC stock in July 2018. Thanks to the latest announcement, the company’s stock is up 129% in the two years since.
Technically, not a small-cap stock with a $5.1 billion market cap, the S/Mid stock ought to become a large-cap stock very soon.
Everbridge makes money by providing businesses with a Critical Event Management Platform to help them react faster to critical events such as the novel coronavirus, keeping their staff and assets safe.
Like iRhythm, it’s more of a Small-Cap/Mid-Cap stock (SMID) rather than a pure small-cap, which by definition, are those companies with market capitalizations between $300 million and $2 billion.
That’s okay. Investing is about owning small pieces of great companies, not fitting your strategy into a specific sized company.
Year to date, the company is having an excellent performance in the markets. It’s got a total return of 92.5%. As I write this, Everbridge is readying to report its second-quarter results. In the first quarter, it grew sales by 38% to $58.9 million, ending the quarter with 5,218 global enterprise customers, 15.1% higher from the same quarter in 2019.
While it’s still losing money on both a GAAP and a non-GAAP basis, Covid-19 has proven the future is bright for this global software company.
Alarm.com Holdings (ALRM)
Alarm.com is the high tech version of the traditional residential and commercial alarm company. It utilizes the internet to provide a cloud-based software platform for subscribers to manage their internet-enabled devices. This includes security, video, access control, energy management, etc., from anywhere in the world.
On August 5, Alarm.com reported second-quarter earnings that included a 16.4% increase in sales to $141.6 million, along with a 5.4% increase in adjusted EBITDA of $29.2 million. Except for a small disruption in its business due to Covid-19, it continues to fire on all cylinders.
That’s why InvestorPlace’s Joel Baglole recently made ALRM stock one of four Internet of Things (IoT) stock recommendations. Joel highlighted the fact that the global smart security market is expected to grow 24% annually over the next three years to $21 billion.
Alarm.com expects to be a big part of this growth.
Source: Pavel Kapysh / Shutterstock.com
Of all the stocks on my list, Cardlytics is probably the toughest small-cap stock to recommend at the moment, because the pandemic has hit the company’s advertising platform quite hard.
The company partners with financial institutions to make tailormade offers to their customers based on the data it collects around purchases made by those customers. Almost all of its revenue is generated through its proprietary Cardlytics Direct advertising channel.
In the second quarter, Cardlytics saw its revenue fall 42% to $28.2 million. Its billings fell 46% during the quarter to $39.5 million. As a result, on a non-GAAP basis, it lost $10.2 million during Q2 2020, about four times worse than a year earlier.
However, there was a positive: Financial institutions saw their monthly active users (MAUs) increase by 31% to 157.2 million. As the world gets back to an average amount of spending, Cardlytics will benefit from this significant uptick in MAUs.
In the meantime, CDLX stock lost about 11% of its value on the news. Can you say “buy on the dip?”
Goosehead Insurance (GSHD)
While some of the small-cap stocks on this list rely on high-tech products and services to grow their businesses, Goosehead Insurance uses good old-fashion customer service to win over customers.
Based in Texas, it is a rapidly growing, independent personal lines insurance agency. This means that its corporate and franchised sales force represents over 100 insurance companies that underwrite personal lines and small commercial lines risks to customers across the country.
On July 30, Goosehead reported an outstanding second quarter that included a 54% increase in revenues to $29.9 million and a net income of 19 cents a share, 217% higher than a year earlier.
Due to its success over the first half of 2020, the company announced a special dividend of $1.15 a share for shareholders of record as of the close of business August 10. If you’re reading this after August 10, don’t despair. There will be plenty of capital appreciation over the next few years as it continues to grow its business.
GSHD stock has a YTD total return of 157.5%.
Newmark Group (NMRK)
Click to EnlargeSource: Shutterstock
As we get farther down the list of small-cap stocks, the names get a little more familiar to me. Some of them, including Newmark Group, I’ve recommended before. In May, I included the commercial real estate advisor in a group of 10 penny stocks worth considering under $5. It’s gone sideways in the two months since.
At the time, I suggested investors would need some patience as the commercial real estate market was expected to take a beating over Covid-19 and a move to working from home.
On August 5, Newmark announced its second-quarter results. As expected, revenues fell 30.4% during the quarter to $383.7 million, while adjusted EBITDA declined 59.0% during the quarter to $45.6 million.
“Despite significantly lower industry transaction volumes in the second quarter, we generated $47 million of cash flow from operations,” stated Chief Executive Officer Barry Gosin.
“We finished the quarter with over $300 million in cash and cash equivalents, nearly $450 million in mortgage servicing rights, and approximately $680 million of expected proceeds from Nasdaq that are not yet reflected on our balance sheet. These significant assets, taken together with Newmark’s operating earnings potential, represent a very attractive investment.”
Down 67.8% YTD, I couldn’t have said it better myself.
Fox Factory Holding (FOXF)
I’ve been familiar with Fox Factory for several years for two reasons.
First, I’m smitten by sports-related businesses. I don’t do any offroading, but for anyone who does, its shocks and forks are top of the line. Secondly, it once was part of Compass Diversified Holdings (NASDAQ:CODI), a holding company I’ve recommended in the past that spun it off in 2013, for a substantial profit.
Unfortunately for CODI, the nature of its business (private equity) required that it exit its ownership at some point. Over the past five years, FOXF stock has generated an annualized total return of 44.0%, four times the entire U.S. market.
Up 598% since its IPO in 2013, I expect it will continue to outperform the markets. Buy on a pullback below $100.
Howard Hughes (HHC)
If you’re a business history buff, as I am, Howard Hughes, the man, will always be an intriguing figure.
Howard Hughes, the company, got its start in 1950 when the billionaire bought land in Summerlin, Nevada, which ultimately became a master-planned community (MPC).
The past year hasn’t been an easy time for the real estate company. In October 2019, the company announced a transformation plan that included the CEO and president, both stepping down from their positions.
CEO David Weinreb, who had been the chief executive for nine years, was replaced by Paul Layne, the head of its Central Region. The plan including cutting annual operating expenses by $50 million, selling $2 billion in non-core assets, and accelerating the growth of its core MPC assets.
Bill Ackman is chairman and controls 12.2 million HHC shares or 22.2% of its stock. He’s been on a roll in 2020, so I wouldn’t be surprised if this value play turns in his favor.
Source: Who is Danny / Shutterstock.com
If you were brave enough to buy Trex stock at the market bottom in mid-March and still hold, you’ve more than doubled your money in slightly less than five months. Not bad for a half-year’s work.
The manufacturer of eco-friendly composite outdoor products, such as decking and fencing, has managed to weather the Covid-19 storm better than most.
On Aug. 3, it announced second-quarter results that included a 7% increase in sales ($221 million) and a 33% increase in earnings to 81 cents a share. The company said its EBITDA margin in the quarter improved by 580 basis points to 30.6% while its gross margin rose 150 basis points to 41.9%.
In this economic environment, if you’re growing sales, you are way ahead of the game. Over the past 15 years, it’s delivered an annualized total return of 22.0%. It will stumble from time to time, but Trex is an excellent long-term hold.
Stag Industrial (STAG)
The second of two real estate stocks, Stag Industrial is a real estate investment trust (REIT) that owns 91.8 million square feet of single-tenant, industrial properties in 38 states across the U.S. Like many of the stocks on this list, it’s more of S/Mid-Cap stock, with a current market cap of $5.0 billion.
I think you’ll find that some of the best growth opportunities right now are stocks in the $4-8 billion range. Stag is one of them.
Since Stag’s IPO in August 2011 at $13 a share, the REIT has done an excellent job growing its business while also strengthening it. In 2011, it had 14.2 million square feet. Today, it’s almost seven times greater. Yet, its debt as a percentage of its total capitalization has fallen from 46.8% at its IPO, to 26.1% today.
Stag estimates that the U.S. industrial real estate market has more than $1 trillion in assets. The REIT’s share of that is less than 1%. It’s got plenty of room for growth. In 2019, its investment team weeded through more than 1,250 potential opportunities. It closed on just 61.
With a nose for value and diversification model that prevents overexposure to any one market, the quality of its portfolio is likely to get even better than it already is.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.