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5 Top-Ranked Picks That Will Continue the Small-Cap Rally

Zacks Investment Research

Small-cap stocks are enjoying a good year. While the benchmark S&P 500 is up only 0.6% year to date, the Russell 2000 and the S&P SmallCap 600 indices have gained 4.9% and 6.3%, respectively, over the same period. Last week, this class of stocks enjoyed a record run of gains. The Russell 2000 hit record highs over three consecutive sessions.

5 Top-Ranked Picks That Will Continue the Small-Cap Rally

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Analysts feel that the recent run of gains is likely to continue for small caps. This is because a combination of factors is working in their favor. An analyst from investment bank B. Riley FBR thinks the Russell 2000 will hit 1800 by the end of the year, increasing 16% year over year. Picking small-cap stocks looks like an exceedingly profitable option at this point.

Domestic Focus a Major Positive

One of the major advantages that small-caps hold over their large-cap peers is their strong domestic focus. Per data from S&P Dow Jones Indices, domestic revenue exposure for companies which make up the S&P SmallCap 600 index is 78.8%. This is significantly higher than the S&P 500 and the S&P MidCap 400, domestic exposure for which stand at 70.9% and 73.3%, respectively.

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This level of domestic exposure ensures that small caps are insulated from multiple headwinds. These include surging bond yields, a resurgent dollar and trade-related conflicts. In fact, domestic-focused small-caps could even stand to gain from the dollar’s rise.

Over the last 10 years, a 1% increase in the U.S. dollar has been accompanied by a 0.95% increase in the value of small caps. In contrast, mid-caps and large-caps have gained only 0.82% and 0.71%, respectively, over the same period.


Poised to Grow in Historically Unfavorable Phase

According to Morgan Stanley (MS), the United States is in the end stages of its current economic cycle. Historically, such a period is considered detrimental for small and mid-cap stocks. This is because wage increases and other cost hikes crimp margins at a time when such companies have few options to increase efficiency. But this trend is unlikely to be repeated this time around.

However, growth in revenues has been “underwhelming” during the current economic recovery, per the investment bank. Morgan Stanley feels that large caps have been able to boost results through cutbacks and inorganic growth. Small caps have been unable to resort to such tactics.

But this state of matters is likely to change soon. Tax cuts ushered in last year and extensive deregulation are likely to “disproportionately benefit” small caps going forward. This, in turn, would boost earnings performance for the group.


Our Choices

Small-cap stocks’ recent run of gains can be attributed to a confluence of factors. Firstly, their domestic focus insulates them from a variety of external risk factors. Additionally, they are well-poised to grow during the end stages of an economic cycle, a phase where they have historically performed poorly.

Adding small-cap stocks to your portfolio looks like a smart choice at this point. However, picking winning stocks may be difficult.

This is where our VGM Score comes in. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM Score.

We have narrowed down our search to the following stocks, each of which has a Zacks Rank #1 (Strong Buy) and a good VGM Score.

Turtle Beach Corp (NASDAQ:HEAR) is an audio technology company.

Turtle Beach has a VGM Score of A. The company’s projected growth rate for the current year is more than 100%. The Zacks Consensus Estimate for the current year has improved by more than 100% over the last 30 days. The stock has gained more than 100% year to date.

Nanometrics Incorporated (NASDAQ:NANO) is a leading provider of advanced, high-performance process control metrology and inspection systems used primarily in the fabrication of semiconductors and other solid-state devices.

Nanometrics has a VGM Score of A. The company has expected earnings growth of 84% for the current year. The Zacks Consensus Estimate for the current year has improved by 36.6% over the last 30 days. The stock has gained 52.3% year to date.

Addus HomeCare Corporation (NASDAQ:ADUS) is a comprehensive provider of a broad range of social and medical services at home.

Addus HomeCare has a VGM Score of B. The company’s projected growth rate for the current year is 24.4%. The stock has gained 47.6% year to date.

Malibu Boats Inc (NASDAQ:MBUU) operates as a designer, manufacturer and marketer of sport boats primarily in the United States.

Malibu Boats has a VGM Score of A. The company has expected earnings growth of 51.5% for the current year. The Zacks Consensus Estimate for the current year has improved by 8% over the last 30 days. The stock has gained 46.4% year to date.

QuinStreet Inc (NASDAQ:QNST) is a provider of online direct marketing and media services.

QuinStreet has a VGM Score of B. The company’s expected earnings growth for the current year is more than 100%. The Zacks Consensus Estimate for the current year has improved by 61.1% over the last 30 days. The stock has gained 44.7% year to date.

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