Investing

4 Undiscovered Small-Stock Gems

    

For a long time, academics and investors were convinced that small stocks outperform large ones. The theory was that small stocks, because they carry greater uncertainty, sell at a discount to large ones. Investors in the small fry are rewarded for taking extra risk.

Proving the theory was difficult. Many early studies suffered from survivorship bias. They failed to include some small stocks that ultimately went bankrupt.

One way to look at the issue is to compare the return on the Standard & Poor’s 500 Index (which contains 500 large stocks) with the return on the Russell 2000 Index (made up of 2,000 smaller stocks).

In the past 30 years, big stocks hold a slight advantage, with annual returns of 10.61%, versus 10.51% for the small stocks. In the past 20 years, however, small stocks edged out large ones with a 9.85% return, compared to 8.66% for their larger brethren.

Big institutions generally prefer large stocks, because if you have billions of dollars to invest it’s easier to hold shares in big companies: You can trade them without moving the price much.

For my part, I remain a fan of small stocks. They are usually covered by at most a handful of analysts, whereas large-capitalization stocks may be followed by two or three dozen analysts. I believe your chances are better of finding an underpriced stock among the smaller issues.

Here are four small stocks I recommend now.

Based in Atlanta, Georgia, Haverty Furniture Cos. (HVT) retails furniture, mainly in the South and Midwest. It lost money during the Great Recession but since then has put together 11 straight profitable years.

Profits have soared lately, perhaps because people who are stuck at home want to fix up their home. The stock sells for only 13 times earnings, a ratio I find attractive. But keep an eye on the company’s debt. If it gets much higher, I’d be concerned.

Ever look up at electrical wires and notice funny oblong devices attached? Relaying electricity and making connections for cable service are some of the specialties of Preformed Line Products Co. (PLPC), which hails from Cleveland, Ohio. The company has relatively little debt, and the stock sells for only 11 times earnings. It has shown a profit for 21 consecutive years.

Interest rates are rising at last, which bodes well for banks. A small banking company based in Manitowoc, Wisconsin, that looks appealing to me is Bank First (BFC). I like to see banks achieve a return on assets of more than 1%, and Bank first has done it for nine years in a row. A few insiders have purchased these shares last year and this year. The stock sells for 14 times earnings.

Lab coats, scrubs, and shirts with company logos…those are some of the products at Superior Group of Companies (SGC). That may not sound like the most exciting business, but the company has grown its revenue at a 13.7% annual clip the past ten years – and faster lately. Because the business is perceived as unglamorous, the stock sells for only nine times earnings.

The Record

Since the beginning of 2000, I’ve written 23 columns about small-cap stocks. The average 12-month return on my picks has been 18.3%, compared to 8.3%% for the Standard & Poor’s 500, and 11.8% for the Russell 2000.

Of the 23 sets of recommendations, 18 have been profitable, 15 have beaten the S&P 500, and 15 have beaten the Russell 2000.

Bear in mind that my column results are hypothetical: They don’t reflect actual trades, trading costs or taxes. These results shouldn’t be confused with the performance of portfolios I manage for clients. Also, past performance doesn’t predict future results.

A year ago, the stock market had been reeling from the onset of the Covid-19 pandemic. Stocks plummeted in February and March 2020, and in retrospect, the stock-picking environment in April 2020 was rich with opportunity.

Both the indices and my picks did very well in the 12 months from April 13, 2020 to April 13, 2021. The S&P was up 52.5%, and the Russell 2000 was up 86.0%. My picks returned 104.5%.

The best gainer was Johnson Outdoors
JOUT
, up 147.6%. The “worst” was Miller Industries (MLR), up 63.1%. In between were America’s Car-Mart (CRMT) with a 124.1% return and Diamond Hills Investment Group (DHIL), with 83.1%.

Disclosure: I own America’s Car-Mart personally and for most of my clients. I own Miller Industries personally and in a hedge fund I manage; the fund also owns Preformed Line Products.

——

John Dorfman is chairman of Dorfman Value Investments LLC. His firm or clients may own or trade securities discussed in this column. He can be reached at [email protected].

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