Small is still beautiful, especially when it comes to stock investing. And interestingly, after a long period of underperformance, small-cap stocks have been besting the large-caps since February. Close watchers of the market’s various sectors argue that small-cap investing has proven to be the better play over the long term. These little-company stocks are the typically included in the Russell 2000 rather than the S&P 500, which tracks the market’s large-value shares.
“It is well documented that one dollar invested in small cap stocks from 1925 to today would return $27,000, as compared to only $5,000 for the S&P 500 and only $110 for U.S. Treasury securities,” said Nick Galluccio, head of small-cap investing at Teton Advisors, a unit of investment firm Gabelli & Co.
He noted that small-cap stocks are generally investment plays on the U.S. economy, which continues to outperform the economies of other major countries.
True, the small caps have been on the rise along with the major stock market averages, which have continued to establish new all-time highs (chart below). But the pint-size stocks remain attractively priced nonetheless, according to a recent Bank of America/Merrill Lynch report, which points out that they’re undervalued compared with the large-caps -- for the first time since 2003.
And yet, the discerning investor may be wiser to look beyond the market indexes to find ample opportunities because not all small-cap stocks in the index move in tandem, and greater upside potential is likely to be found in shares that have yet to benefit from the upswing in prices.
Analysts argue that superior innovation in products, as well as nimbleness in addressing markets to gain first-mover advantage are twin factors that help small companies capture market share and drive up revenue and earnings growth.
It’s not easy to pick out the small-cap stocks that should outperform, but here are three that stand out in pursuing such a growth strategy, according to some savvy watchers of the mini-cap subsector. All these companies are leaders in industries or businesses that many investors don’t yet understand or appreciate:
CUI Global (CUI), a global provider of power and electro-mechanical products and technologies, which recently won a major contract from SNAM RETE Gas, a large Italian gas transmission company.
Infinera (INFN), a provider of optical networking equipment that enables companies, such as Time Warner Cable and Cablevision (CVC), as well as telecom giant Verizon (VZ), to transmit vast amounts of data over a single optical fiber.
Orion Engineered Carbons (OEC), a leading global producer of specialty carbon black products for coatings and printing applications, as well as various conductive carbon black grades for use in battery electrodes and other applications.
Its big contract from SNAM RETE Gas is for the delivery of technology for gas measurement and analysis. The initial order is valued at about $20 million, but the contract’s total price tag is $160 million. CUI’s stock, however, has been a disappointment, although some contrarians believe it’s an opportunity at its currently depressed price.
The stock has yet to reflect the significance and value potential of the SNAM RETE contract. On Feb. 11, 2016, the day following the contract announcement, the stock closed at $7.47 a share, and by March 9, had surged to $9.25. But it has pulled back since, to a low of $4.86.
Yet business fundamentals remain upbeat. Total revenues in 2015 had climbed to $86.7 million, up from $76 million in 2014. So some analysts see the stock’s slump in as a chance to buy on the cheap. CUI has yet to make money, but some analysts expect it to post profits in 2017.
Eric Stine, research analyst at investment firm Craig-Hallum, who rates the stock as a “buy,” has a price target of $12 a share. He and several other bullish analysts are optimistic about CUI’s gas technology, known as Gas PT, which analyzes and measures the physical properties of natural gas, including its quality level in nearly real time.
Some analysts note that CUI’s technology is a substantial improvement over existing traditional gas chromatography, which cost from $250,000 to $500,000, as compared with $50,000 for a CUI Gas PT device.
Amit Dayal, analyst at Rodman & Renshaw, who rates CUI a “buy,” says the “low cost, higher efficiency and faster response time of the Gas PT technology should help CUI capture a large share of the global [gas chromatography] market, projected to be approximately about $3.8 billion by 2019.”
One issue is whether the declining energy prices might impede market demand for CUI’s Gas PT system as capital spending is deferred and budgets slashed. Not true, according to some analysts.
Robert Brown, senior analyst at Lake Street Capital Markets, doesn’t think that’s a legitimate concern. “We believe CUI’s growth profile is unrelated to oil prices and should not see headwinds in the current environment,” Brown argues. He has a target price of $11 a share for CUI’s stock, which closed on Monday up 4.8 percent, o 23 cents, at $5.04.
Teton Advisor’s Galluccio is high on this maker of optical networking equipment that telecoms use as well as Internet content providers and enterprise networks to transport images and videos. The company’s revenues are mostly derived -- some 80 percent -- from the North American “long-haul” market. Infinera is now diversifying into the metro, or local, end of the business as well as extending offerings for cloud-based services to further expand its reach.
Infinera’s stock has been hammered due to what Galluccio described as short-term issues in the long-haul market, caused by an abrupt pause in spending by Tier 1 telecom customers.
He believes the stock, which closed at $9.09 a share on Monday (up 0.6 percent, or 5 cents), could double in price within 18 months, partly because Infinera has introduced a new-generation product known in the industry as Gen4, which is poised to benefit from expanded optical bandwidth usage as mobile applications such as video streaming proliferate.
Galluccio also pointed out that Infinera’s CEO has purchased 200,000 shares, which is usually a signal of management’s confidence in the future of a company.
Orion Engineered Carbons
This is another stock to watch because it’s the market leader in the production of high-margin “specialty carbon black” that’s used as a pigment and performance additive in coatings, polymers, and printing. The essence of carbon black is derived from refined oil, gas or coal tar, which is then engineered through a complex manufacturing process technology.
The company has three discrete manufacturing process technologies: furnace black, which uses heavy petroleum oil or coal tar; thermal black, which uses natural gas to make carbon black; and lamp black, a specialty carbon black derived from the incomplete combustion of oil. This diversity lets Orion fill a wider variety of market needs.
Christopher Kapsch, analyst at BB&T Capital Markets who rates Orion stock a “buy,” has a 12-month price target of $24 a share. The stock is currently trading at $18.32, up on Monday by 0.7 percent, or 13 cents. Its high dividend yield of 4.11 percent adds a handsome attraction to the stock.
Orion essentially has no major competitor in gas black and lamp black process technology, noted Kapsch. Another area in which the company excels, said the analyst, is in the production of rubber carbon black, which is used mainly to make tires.
To maintain its competitive advantage, Kapsch said Orion’s innovation group works very closely with its clients in the development of new products and applications.