You may not have heard of these small-cap growth stocks. And that’s a big reason why you should consider investing in them.
Growth stocks—at least large caps and mid caps—have been holding up the market during this pandemic siege. So far this year, large-cap growth stocks are up 11.2% and mid-cap stocks 5.4%. However, small-cap growth stocks are still in the red, losing about 3% in 2020.
I think the market is going to continue to be volatile until we either 1) get a coronavirus vaccine; or 2) find some good treatments for the often devastating symptoms.
Right now, more than 30 states have seen COVID-19 accelerate since reopening began. So, I think it’s more of the same for a while. With that in mind, I reviewed investing styles and sectors to determine the best places to invest right now, and my research just kept bringing me back to small-cap growth stocks. The category, as I said, is underperforming right now, but I believe as soon as the coronavirus gets under some measure of control, this will be the next breakout spot.
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Now, 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 9.8% 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 have been worth $77,472.40 today. Likewise, if you bought shares of Facebook (FB) eight years ago this week, in 2012, you would be sitting on a 709% gain right now. And a 1992 investment in Starbucks (SBUX) would have given you a 17,467% 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)
- At least 25% annual forecasted EPS growth over the next five years
- Positive institutional interest
- Daily volume of at least 300,000 shares
- Price above the 200-day moving average
- Price under $15 (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:
Each of these companies—due to high expected growth—are 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. Consequently, 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.
Nancy Zambell, Editor of Wall Street’s Best Investments, has spent 30 years helping investors navigate the minefields of the financial industry. Nancy scours more than 200 advisories and research reports to select the top recommendations, which she collects for you in this easy-to-read digest.Learn More
*This post has been updated from an original version.