You may not have heard of these small-cap growth stocks. And that’s a big reason why you should consider investing in them.
Value stocks have been leading the markets since the pandemic began to wane, with large caps returning 20.3%; mid-caps, 24.8%; and small caps, 26.5%. But recently, growth stocks have been fighting to regain their lead. So far this year, large-cap growth stocks have jumped to the front of the line, rising 26.9%, with mid-caps at 13.5%, and small caps ahead 4.8%.
Small caps tend to outperform when the economy is healthy and growing. That has been the case since the COVID-19 vaccines appeared, but much uncertainty has remained. The CDC reports that just 61.1% of Americans are fully vaccinated; we have a new omicron coronavirus variant for which not much is yet known as far as speed and ease of contagion, or if the existing vaccines can successfully prevent it.
Yet, the economy has gained significant strength. The housing market is on fire price wise, but inventories remain limited, suppressing sales. GDP is growing steadily, and the unemployment rate has fallen to 4.2%, the lowest since the pandemic began.
The pandemic’s days are numbered. Much progress has been made with the vaccines, but face it, coronavirus may be like the flu, requiring a vaccine every year. And if that’s the case, we will return to normal—maybe a different normal—but the economy will continue to thrive.
Consequently, I believe the time is right for a rally in small-cap stocks. Last month, the Russell 2000 index showed momentum driving it up, then a dip due to omicron. Since then, the small-cap universe has been slowly rising, but I think there’s much more to come.
And I love to buy stocks before they get on everyone’s wish list. So, I’ve run my programs, looking for the best small-cap growth stocks, and I’ve come up with five that I think you’ll like.
But, before I give you my results, let’s just take a moment to review what growth stocks mean to investors.
Growth Stocks 101
A growth stock is a stock whose earnings are expected to outpace the market average, or, often, companies that are not yet profitable, but are seeing tremendous revenue increases. Earnings growth (or the expectation of earnings growth) is the biggest determinant of stock price appreciation. Consequently, companies whose earnings are growing—or anticipated to grow at a fast pace—all other market and economic factors being equal, should also enjoy above-market returns on their share prices. The average annual market gain for the S&P 500 Index (an index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or Nasdaq) is 10% over the past 90 years. Therefore, a growth stock would be expected to enjoy higher returns than the market average.
Examples of growth investments may include smaller companies that have high potential for growth (such as start-ups), cutting-edge technology firms, biotech businesses with promising new drugs, emerging market stocks from less developed countries, and companies that—for one reason or another—have fallen on hard times, but are now “turning around.”
Legendary growth investors included Thomas Rowe Price, Jr., often called “the father of growth investing” due to his comprehensive research on growth stocks; and Philip Fisher, author of the 1958 book, Common Stocks and Uncommon Profits.
As those two gurus would confirm, growth investments can be extremely profitable. For example, a $100 investment in Apple (AAPL) stock in 2002 would be worth $220,500 today. Likewise, if you bought shares of Facebook (FB) nine years ago this week, in 2012, you would be sitting on a 976% gain right now. And a 1992 investment in Starbucks (SBUX) would have given you a 29,576% return!
And while that sounds phenomenal—who wouldn’t want to invest in growth stocks?!—that’s not the whole story. High-flying stocks also come with some big risks. After all, my mother always said, “What comes up, must come down,” and she was mostly right.
Because growth stocks typically trade at a higher premium (due to demand), those lofty valuations tend to be volatile, and are much more susceptible to rapid declines than their value peers.
Consequently, while a growth investor can reap amazing rewards, it’s important to recognize that they may come with a few sleepless nights. In other words, be prepared to ride out some wild swings if you are a dedicated growth investor.
Here are the four primary characteristics that interest most growth investors:
- Robust historic and forecasted growth rate, usually 10% or more.
- Strong Return on Equity (ROE, or net income divided by shareholder’s equity). Compare the company’s ROE with its five-year average as well as the ROE of its industry.
- Solid advances in earnings per share (EPS), or revenues in the case of newer companies that have not yet posted profits. A subset of EPS is the pre-tax profit margin, which should surpass the industry average and the company’s five-year average.
- Analysts’ estimated future stock price should indicate growth at least in the double digits, but true growth investors often look for a double in five years.
One more caveat to growth stocks: The higher growth companies do not usually pay dividends, or if they do, they generally have dividend yields less than 2%. That’s because growth companies usually reinvest their earnings in order to accelerate their growth over a short time period.
5 Small-Cap Growth Stocks to Consider
Okay, now that we’ve defined what we are looking for in a growth stock—and the risks we agree to undertake—let’s get to the bottom line: the results of my research.
First, here are the parameters I used:
- Small cap ($300 million – $2 billion market cap)
- Positive annual forecasted EPS growth over the next five years
- Positive institutional interest
- Price above the 200-day moving average
- Price under 40 (I wanted to make sure you got the biggest bang for your buck!)
Next, I ran my screener, then checked to make sure that—on a technical basis—the time looked right to buy.
And here are my results:
|Allied Motion Technologies Inc.||AMOT||37||Electronic Components||1.7|
|TCG BDC, Inc.||CGBD||13||Asset Management||2|
|Electromed, Inc.||ELMD||12||Medical Devices||1.5|
|Green Brick Partners, Inc.||GRBK||29||Residential Construction||2.2|
|Shore Bancshares, Inc. (SHBI)||SHBI||20||Regional Banks||2|
Each of these companies—due to high expected growth—is going to be more volatile than the average stock. So, once you’ve reviewed them to determine if any fit into your investing strategies, please keep that in mind, and do not chase the prices upward.
Lastly, you will be well-served if you use stop-losses, and with these more volatile equities you may want to consider 30% stops, so that you don’t get stopped out during a volatile period.
Which small-cap growth stocks do you invest in?
*This post has been updated from an original version, published in 2020.