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Small Business Optimism Hits 7-Month High in May: 5 Top Picks

Nalak Das

Small business organizations remained undeterred by intensifying trade conflict between the United States and China. Owners are more confident about business prospects despite trade tussle. Aside from large-cap stocks, small caps have also witnessed significant growth in 2019.

At this juncture, small-cap stocks are likely to emerge as diamonds in the rough, pushing aside large caps. Strong fundamentals of the U.S. economy and immunity to external disturbances have increased these stocks' popularity.

Small Business Optimism at Historical High Level

On Jun 11, the National Federation of Independent Business (NFIB) reported that the NFIB Small Business Optimism Index rose 1.5 points to 105 in May, the highest since October. A net 9% of all seasonally adjusted owners reported higher nominal sales in the past three months, reflecting an improvement of four points.

Six of 10 survey components increased, three were unchanged, and only one fell in May. A large chunk of 62% owners reported hiring or trying to hire, 5 points higher sequentially while 64% owners reported spending on capital equipment, reflecting a gain of 6 points sequentially and the highest since February 2018.

Despite a tight labor market and increasing hiring costs, total respondents, who said that they hiked their selling prices, declined a net 10%. This indicates that inflation is likely to remain muted going forward.

Why Small Business Is Important?

Small corporates create significant amount of jobs in the U.S. economy. More than 50% of the newly created jobs in the private sector originate from this sector. These people constitute a large part of customers for big businesses.

Moreover, small companies are a major part of the supply chain management systems of large companies for innovative and technologically superior inputs. Additionally, small businesses often end up being an important part of corporate America's customer base.

Meanwhile, the Russell 2000 (RUT) -- the benchmark index of small-cap stocks -- has jumped 12% year to date.

Small Caps Are Important During Volatility

Small-cap stocks carry some special features which make them very useful in a volatile market. Small-cap stocks are mostly immune to any external shock since the United States is the primary market of their products. This is aiding this segment to outperform the broader market defying extreme volatility.

Owing to their domestic business strategy, small-cap stocks are immune to the movement of the U.S. dollar.  A strong U.S. dollar will make exports of large companies uncompetitive. However, small-cap stocks remain unaffected by foreign exchange volatility.

Small-cap companies generally benefit first from an improving domestic economy. A strong economic condition tends to coincide with rising interest rate. However, in order to fund expansion, small-cap companies are less likely to take the debt route compared with their larger peers, making them less sensitive to the interest rate movement.

Additionally, reduction of corporate tax from 35% to 21% is a major catalyst for small-cap companies. These entities book almost all of their revenues in the homeland. As a result, a significant reduction in the corporate tax rate is immediately accretive to their cash flow.

Our Top Picks

At this stage, it will be prudent to invest in small-cap stocks with a favorable Zacks Rank and strong growth potential. We have narrowed down our search to five stocks with a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The chart below shows price performance of our five picks in the past three months.

Limbach Holdings Inc. LMB provides commercial specialty contract services in the United States. It operates in two segments, Construction and Service. The company has an expected earnings growth rate of 305.8% for the current year. The Zacks Consensus Estimate for the current year has improved 78.3% over the last 60 days.

Hibbett Sports Inc. HIBB engages in the retail of athletic-inspired fashion products through its stores in the United States. The company has an expected earnings growth rate of 18.1% for the current year. The Zacks Consensus Estimate for the current year has improved 11.2% over the last 60 days.

SB One Bancorp SBBX provides commercial banking and related financial services to individual, business, and government customers in the United States. The company has an expected earnings growth rate of 36% for the current year. The Zacks Consensus Estimate for the current year has improved 9.1% over the last 60 days.

Noodles & Company NDLS develops and operates fast-casual restaurants in the United States. It offers cooked-to-order dishes, including noodles and pasta, soups, salads, and appetizers. The company has an expected earnings growth rate of 700% for the current year. The Zacks Consensus Estimate for the current year has improved 33.3% over the last 60 days.

Middlesex Water Co. MSEX owns and operates regulated water utility and wastewater systems in the United States. It operates in two segments, Regulated and Non-Regulated. The company has an expected earnings growth rate of 10.7% for the current year. The Zacks Consensus Estimate for the current year has improved 5.9% over the last 60 days.

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