Small caps are holding up well, and despite the jump in volatility in tech stocks, they’re even starting to firm up and trade in a tighter range. As you can see in the one-year chart of the S&P 600 Small Cap Index below, the index hasn’t dropped much below its 50-day line since the beginning of June.
This holds true if you look at the Russell 2000 too. And even if you look at both the value and growth ETFs that track those components within the two small cap indexes. It’s even true of the Russell MicroCap index, which is the best performing of the group since June 1.
Bottom line: broadly speaking, small caps look pretty good from a technical perspective. They remain relatively expensive on a forward price-to-earnings basis (forward P/E of 19). But not too bad on a forward price-to-sales basis (forward P/S of 1).
In my 2017 Small Cap Forecast, I suggested a year-end target on the S&P 600 in the 885-927 range, which implied a 5%–10% gain on the year, and as much as 8% upside from here. This target range was based on a year-end forward P/E of 18-19 based on 2018 expected earnings of $48.80 for the index. Current consensus is for $48.68, so not much has changed on that front.
Two things are worth mentioning here. First, that 2018 EPS estimate implies S&P 600 earnings grow by almost 19% over 2017 (consensus currently calls for EPS of $40.92 this year). Second, EPS grows throughout the year, with Q2 greater than Q1, Q3 greater than Q2, and so on. The punch line is that as we now progress into Q3, forward valuations should come down (assuming the index stays where it is). The reason is that as Q2 2017 EPS slides into the trailing EPS category, it will be replaced in the forward EPS category by Q2 2018, which will be a much greater number. That increases the overall forward EPS estimate (the denominator in the P/E ratio), which drives down the forward P/E (assuming the S&P 600 doesn’t change much).
Yes, this is a boring topic to read about (probably better discussed over a beer). But it’s also basic math, and it’s important to understand given that there is so much focus on market valuation right now, and that institutional investors will have more wiggle room to buy if valuations don’t get crazily extended. It also illustrates how small caps can still go up a little (5%–10% in 2017) while the forward P/E comes down by year-end (target P/E of 18–19).
In short, the upcoming Q2 earnings season will be crucial (again) to confirm that expected growth in revenue and EPS is tracking as forecast.
Now that I’ve put you to sleep, it’s time to jolt you back awake with a chart of our performance over the past week!
As you can see, almost everything went up. On average, our portfolio rose by 3.2% this week. That pleases me because it was twice as much as the small cap index. Across our 11 positions, we have an average gain of 32%, which is 22.7% better than you’d have done if you just bought the Russell 2000 every time I recommended one of our current stocks.
We’re two weeks away from our first earnings report. I expect this to be another exciting earnings season so enjoy a few weeks of relative calm before the craziness starts up again.
Updates
Airgain (AIRG) No meaningful news over the past week and the stock keeps moving sideways. Expect more action around earnings, but that event shouldn’t be until September. Keeping at Buy. BUY.
AppFolio (APPF) The stock still looks good after bouncing off the 31 support zone last week and rising by 4% this week. Shares are still below their recent 52-week high. BUY.
Asure Software (ASUR) The stock jumped 7% this week after finding support at 14 over the past two weeks. Earnings are due out in about a month, and we’ll be looking for insights into the recent acquisitions, integration progress and plans for additional tuck-in purchases. Keep holding. HOLD.
AxoGen (AXGN) The stock has been moving sideways and looks like it could easily drop back to 15.5. Continue to average in and placing your limit buy orders down near 14.5–15.5 to help keep a lid on the price (for now). BUY.
BioTelemetry (BEAT) As expected, management announced it completed the LifeWatch AG acquisition this week. The team should now be cranking through integration work so it has a ton of great news to share with us on the next quarterly earnings call. That should be around the end of the month. BUY.
Everbridge (EVBG) As expected, the stock found support around 23, but hasn’t done a whole heck of a lot over the past week. It looked like a move back toward 25 was coming, but shares stalled out yesterday. Keep holding half. HOLD HALF.
Announced earnings date: August 3
LogMeIn (LOGM) The stock came roaring back this week after two months of choppy trading that cut it down from 120 to 103. Earnings, the date for which was just announced, could be a pivotal event given the magnitude of the GoTo acquisition and the fact that shares are trading right on their 50-day line. HOLD HALF.
Announced earnings date: July 27
MindBody (MB) The stock continues to look weak and is in no-man’s land at the moment. We know a significant acquisition should be on the table, but there’s nothing concrete to go on, other than the secondary offering. Earnings is two weeks away and I think that day can’t come soon enough. We need a catalyst here. HOLD HALF.
Announced earnings date: July 27
Primo Water (PRMW) The stock finally stopped its three-week descent to 12 and bounced back to its 50-day line this week. If you back up and look at the one-year chart, you’ll see just how choppy the stock has been.
This isn’t overly surprising given that it just completed a major acquisition and its market cap is still under $400 million—but I’d like to see a more consistent trend in the stock. That said, I love the story, think there is potential for meaningful debt reduction over the next 12 months, and significant potential synergies (margin growth, back office stuff, etc.) resulting from the Glacier acquisition. Also, I think the endgame here is for Billy Prim to sell the company. Not now, but within the next five years. BUY.
Q2 Holdings (QTWO) The stock was strong this week, affording you a chance to sell some shares into strength (if you followed my advice from last week). There were no new fundamental developments. HOLD HALF.
U.S. Concrete (USCR) Our concrete stock is still trading near its 52-week high, and I’m continuing to recommend holding until it has a chance to digest this latest move. HOLD.
