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How to Invest in Small Cap Value Stocks

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Tired of the large cap stocks and want to spice up the portfolio with some small caps?
In this article:
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  • (0:30) - Small Cap Value Stocks

  • (6:15) - Tracey’s Top Stock Picks: QUAD & RBBN

  • (10:50) - 3 Small Cap Value ETFs: SLYV, VBR, DLS

  • (17:35) - Episode Roundup: Podcast@Zacks.com

Welcome to Episode #107 of the Value Investor Podcast

Every week, Tracey Ryniec, the editor of Zacks Value Investor portfolio service, shares some of her top value investing tips and stock picks.

It’s no secret that small cap value stocks have outperformed, historically, all other equity classes.

But that hasn’t been the case over the last 5 years. Large caps, especially large cap growth stocks, have crushed their small cap counterparts.

However, in 2018, with worries over trade impacting the multinationals, many investors have been rotating into the small caps.

Some of the small cap ETFs are up double digits in 2018, out performing the S&P 500.

How can you invest in small cap value stocks in your portfolio?

Problems with Investing in Small Cap Stocks

It’s not easy to invest in small cap stocks for the following reasons:

1.       Not as many analysts cover them. In some cases, there may only be one analyst which makes the data, such as earnings consensus, less reliable.

2.       They’re more volatile as they’re more thinly traded.

3.       It’s more challenging to get a diverse portfolio. You have to really have a large group of small caps to lower your risk.

Still, investing in small cap companies can be a lot of fun even with the headaches. Investors are more likely to find hidden gems among the small caps.

But how do you find them?

Screening for Small Cap Value Stocks

Investors can run a basic value screen which includes a forward P/E of 15 or less and a P/B ratio under 3 along with a market cap of $1.5 billion or less.

Because you want rising earnings estimates, include the Zacks Rank of #1 (Strong Buy) or #2 (Buy).

This screen produced 88 stocks including the following companies:

1.       Quad/Graphics QUAD provides digital and print services worldwide. It has a forward P/E of 12.4 and a P/B ratio of 2.4. It’s market cap is squarely in the small cap range at just $1.2 billion.

2.       Ribbon Communications RBBN is in the intelligent cloud communications industry. Like Quad, it too has international business which is somewhat rare for a small cap company. It has a forward P/E of 14.8 and a P/B ratio of 1.3. Ribbon’s market cap is only $741 million.

But what if you don’t want to find and investigate a random small cap stock?

ETFs are a great way to add diversity to a portfolio.

3 Small Cap Value ETFs to Consider

1.       SPDR S&P 600 SLYV has just 458 stocks in it so it’s a little narrower, and more focused, than some of its competitors. Financials are the biggest industry, at 20.8%.

2.       Vanguard Small Cap Value VBR has 852 stocks in its portfolio. There really aren’t that many value stocks, which means some of the holdings will likely be growth stocks. Financials are the largest industry, at 31%.

3.       Wisdom Tree International Small Cap Dividend Value DLS gets investors some international exposure along with the safety of a dividend, which yields 3.3%. This includes small caps in the developed world who aren’t the US or Canada. Japanese companies make up 24.9% of the portfolio.

Be sure to watch the expense ratios on your ETFs because they can add up and put a dent in returns.

What else should you know about small cap value investing?

Listen to this week’s podcast to find out.

[In full disclosure, Tracey owns shares of SLYV and VBR in her personal portfolio.]

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WISDMTR-INT SCF (DLS): ETF Research Reports
 
VIPERS-SC VALUE (VBR): ETF Research Reports
 
SPDR-SP6 SC VL (SLYV): ETF Research Reports
 
Quad Graphics, Inc (QUAD) : Free Stock Analysis Report
 
Sonus Networks, Inc. (RBBN) : Free Stock Analysis Report
 
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Zacks Investment Research