Looking for Value in Un-Love Small Cap Stocks

Small-cap fund performance has taken a lot of heat lately, and the “small-cap premium” has been called into question. In a recent article for Nasdaq, John Reese, CEO of Validea, explains how the historic outperformance of small-caps compared to large-caps has reversed in recent years. This has raised a lot of questions in the investment community and has led to a study by a team at U.S. hedge fund AQR, the findings of which resurrected the idea of the small-cap premium by introducing the quality factor into the analysis.

The study found that, once the underlying business fundamentals such as profitability, profit growth, earnings stability and dividend payouts were considered and the high quality small-cap firms were isolated, they not only outperformed large caps by a significant margin but they did so consistently across time, industries and markets. Those stocks at the other end of the spectrum, the so-called “junk” stocks, were in fact dragging down the performance of the small-cap category as a whole.

Here are five small-cap stocks that my Guru Stock Screener says are worth a look:
Innospec Inc. (IOSP) develops, manufactures and supplies fuel additives, oilfield chemicals, personal care and fragrance ingredients and other specialty chemicals (market cap of $1.09 billion). Our Benjamin Graham strategy likes the company’s liquidity, low leverage and strong earnings-per-share, and our Lynch-based model gives high marks for the price-earnings-growth ratio of 0.47 (under .50 is considered the best case scenario.

Marcus & Millichap Inc.  (MMI) is a brokerage firm specializing in commercial real estate sales, financing, research and advisory services (market cap of $934 million). Our Kenneth Fisher strategy gives this company a thumbs up for its inflation-adjusted long-term earnings-per-share growth of 38.36%, more than double the minimum of 15% required to pass this screen. The P/E/G of 0.35 and low leverage also satisfy our Lynch model.

LGI Homes Inc. (LGIH) is engaged in the design, construction, marketing and sale of new homes across the U.S. (market cap of $679 million). Our Validea stock screen gives LGIH a perfect score based in part on strong quarterly earnings-per-share growth of 72.73%, and our James O’Shaughnessy screen likes its price-to-sales ratio of 1.01 (versus 1.5 maximum). Coupled with consistent EPS growth,  these  numbers suggest that this growth stock is still cheap to buy.

Fossil Group Inc. (FOSL) is a design, marketing and distribution company that specializes in consumer fashion accessories and operates in the Americas, Europe and Asia (market cap of $1.4 billion). Our Joel Greenblatt-based stock screen likes this company’s 32.84% earnings yield and return-on-capital of 45.61%. Its healthy liquidity (current ratio of 3.60) and low long-term debt to net current assets (0.83) satisfies our Benjamin Graham stock screen.

Sanderson Farms, Inc. (SAFM) is engaged in the production, marketing and distribution of fresh and frozen chicken and prepared chicken items (market cap of $2.0 billion). Moderate price-to-sales ratio (0.73) and long term EPS growth of 31.72% are both pluses under our Fisher model. Our Lynch screen, which considers SAFM a “Fast Grower”, favors the P/E/G ratio of 0.43 and the company’s extremely low leverage.