Small-cap stocks may be poised to move higher

Small-cap stocks enjoyed huge success last year until they peaked in December 2016. The Russell 2000 small-cap index moved mostly sideways through August and since then has added about 100 points to 1,476 now. But if some small-cap market analysts are right, these small fry are headed for a big comeback sometime soon. 

Several of these market pros suggest that a new "small-cap cycle" is on its way that would power the group's renewed vigor.

"We're seeing a synchronized global economic recovery that should benefit some of the more economically sensitive or cyclical areas of the overall market" and small caps in particular, said Francis Gannon, co-chief investment officer at Royce & Associates.

In a recent report to clients, Gannon argued that in the current environment, the globally exposed small-cap cyclicals represent an attractive opportunity and that investors should focus on revenue growth among small-cap companies. Although only a small percentage of revenue is generated outside the US, roughly around 19.8 percent, noted Gannon, "it's significant in certain industries and subindustries within the Russell 2000 index." 

"These are great areas to find global businesses, and people tend to forget that many small-cap businesses are global businesses that generate revenue outside the US  and think global in terms of how they operate," argued Gannon.

"There's a leg there from an earnings perspective that investors are missing," he added. "We expect earnings from these businesses will be doing better as we see this pickup in economic activity outside the US, coupled with a decline in the dollar, as a double opportunity to boost earnings growth," said Gannon.

Some analysts suggest that the industries that have many little-known, undervalued fast-growing small caps are technology, media, and health care.

Lisa Thompson, analyst at Zacks Investment Research, said one of her favored small-cap stocks is Chicken Soup for the Soul Entertainment (CSSE), a content creation and distribution company that focuses on positive messaging. It currently trades around $8.30 a share with a market capitalization of around $100 million. She has a price target of $23.50 a share.

Earlier this week, the company acquired Screen Media Ventures for about $5 million, mostly in cash.

Daniel Kurnos, analyst at investment firm Benchmark, described the acquisition as a "steal" since Screen Media posted revenues of about $3.5 million last year and is expected to generate revenues of $12 million next year, with earnings before interest, taxes, depreciation and amortization (EBITDA) of $5 million. Plus, Screen Media has an appraised value of $25 million, with no debt.

With Screen Media's 1,200-show distribution library and 3,000-show DTC (direct-to-consumer) platform with 15 million active users, "deals like this are extremely rare," said Kurnos. 

"This deal is a home-run for CSSE because beyond the clear value accretion, the company has quickly and inexpensively enhanced its content library, gained greater access to the international distribution market and upgraded its own technology platforms," said Kurnos. 

Last year, Chicken Soup for the Soul acquired a controlling interest in a millennial-focused online journalism platform known as A Plus. Its celebrity founder is actor and investor Ashton Kutcher, who retained a 25 percent stake in the company. A Plus posts short-form video content as well as articles and has an exclusive long-term contract with Chicken Soup's entertainment division.

Analyst Thompson of Zack's estimates Chicken Soup for the Soul will post 2017 revenues of $18.6 million, up from last year's $8.1 million. As a result of the acquisition, the company is expected to post 2017 fourth-quarter adjusted EBITDA that's significantly in excess of $10 million, up from $3.7 million in the preceding year. With its Screen Media purchase, Chicken Soup acquired a robust DTC content distribution platform and a growing library of video content to offer on either pay-per-view or subscription models.

In the health-care sector, an attractive small-cap stock is PAVmed (PAVM), a medical device company seeking regulatory approval for a new technology for the treatment of carpal tunnel syndrome, which afflicts about 5 million people each year and accounts for over 50 percent of all occupational injuries. According to the Agency for Health Care Policy and Research, US workers' compensation costs relating to this disorder and lost work time total about $20 billion a year.

PAVmed's device, called CarpX, is designed to permit procedures that are much less invasive than existing treatments, trimming the recovery time period to only days instead of weeks. "Addressing the carpal tunnel market with a better solution offers PAVmed a potential home run," said a big investor in the company.

PAVmed's management has a proven record of developing and commercializing a number of medical devices, including the AngioVac, which grew into a business called Vortex Medical. AngioVac was eventually sold for $55 million in 2012.

Robert Wasserman, analyst at investment firm Dawson James, has a target price for PAVmed of $10 a share. The stock traded recently at around $4 a share.

Among internationally traded small-caps, Lysogene, which specializes in gene therapy treatments for orphan diseases affecting the central nervous system, is another value investment opportunity. It's listed on Euronext, trading with the symbol LYS, at 4.6 euros a share.

The gene therapy treatment gained wide attention in the medical world after the US Food and Drug Administration tentatively approved such a treatment developed by Spark Therapeutics. Although the FDA's final decision on it won't come until January of 2018, the preliminary positive sentiment indicates the data demonstrates the treatment is effective for inherited genetic disorders, according to one large investor in Lysogene. 

One other major potential boost for the stock is Lysogene's treatment for Sanfilippo Syndrome A, a severely debilitating pediatric condition. Delphine Le Louet, analyst at Societe General, said the expected launch of a pivotal clinical trial for the treatment will be a major catalyst for the stock.

In addition, the analyst says a strong investment attraction is Lysogene's focus on developing treatments for rare conditions that have no approved therapies and a huge potential for premium pricing. Societe General has a price target for Lysogene of 7 euros. 

"Lysogene has a chance to be the first on the market for Sanfilippo A, as well as the first CNS [central nervous system] gene therapy company on Euronext -- and the second in rare disease," said analyst Le Louet.

For investors seeking to invest in actively managed mutual funds that tap into the growth potential of US small and lesser-known companies, T. Rowe Price's New Horizons (PRNHX) mutual fund has long been a reliable investment vehicle. With assets of about $22 billion, the fund consists primarily of shares of small-cap and midsize US companies that offer significant growth prospects.

And for those who prefer a passive index fund, the Vanguard Small-Cap Index Fund (VSCIX) provides wide exposure to the small-cap equity market. The fund tracks a broad index of many smaller companies.

To be sure, Vanguard and T. Rowe Price are among the nation's most highly trusted and reliably managed investment funds.