With the stock market near all-time highs, many investors are getting defensive and buying large high yielding stocks in fear of a sell-off. This strategy makes sense, but how can you be sure the market will come to its senses?
Mr. Market certainly didn’t sell-off in the face of the “fiscal cliff” and with the Fed determined to kill bond yields, this market may just stay sideways for a while.
Making money, while staying still
There’s a few ways investors can win in a sideways market, including options strategies to generate income (selling puts) and to hedge. To learn more about the basics of option investing, go: here.
For now, let’s forget options hedging and the mastery of “straddles” and “strangles;” there’s a simpler way to win sideways.
If you’ve loaded up on defensive names, or even if you’re selling puts for income, a portion of your portfolio should still include Small-Cap Growth stocks. Businesses that outperform dramatically will still see their stock go higher in this market; let’s keep some exposure to that upside.
Here’s a few simple screening metrics that matter when searching for Small-Cap Growers, complete with stocks that meet them and the follow-up questions that’ll make your “homework” complete.
The Golden Metric: Return on Assets (ROA) above 15% for 1 year:
Return on Assets (ROA) is the first place you should start any stock screen. Like it’s less widely available screening brethren ROC, ROA gauges how much profit a company is earning relative to every dollar the company spends to do business.
That’s a profound distinction, many companies beat EPS expectations but take unfavorable risks (like overexpansion) to do so. A high ROA also means a business is fending off competitors and is able to keep up its margins-both are “moat-worthy” distinctions.
Better yet, it shows that a business will show scalable growth; a necessity for small companies. The goal is for the business to earn XYZ% on its invested dollar, no matter how many dollars it invests; here’s a few small-caps that fit this criteria.
Steve Madden is best known perhaps for their women’s line, yet the company also designs and sells shoes for men, and children. Last year (TTM) they were a “SHOO-IN” (sorry) for high ROA, at 16.27%.
Ebix Inc (NASDAQ:EBIX) provides on-demand software solutions for the insurance industry. TTM ROA: 16.42%
Crocs, Inc. (NASDAQ:CROX) is best known for selling its footwear worldwide but the company also sells other apparel, and accessories. Last year Crocs led our “min-pack” in ROA with a staggering return of 17.81%, even as its stock remained neutral.
“Homework” question: Is revenue growing? A high ROA is not a high moat unless people still want to buy your product.
The Silver: Revenues growing in excess of 15%, annually over the past five years.
A careful distinction in this metric is that it judges performance over five years, showing consistent performance. Steven Madden, Ltd. (NASDAQ:SHOO) (19.33%) and Crocs, Inc. (NASDAQ:CROX) (23.06%) clearly have benefited from the recent shoe “bull” led by NIKE, Inc. (NYSE:NKE), but will that continue?
It may, but a business like Ebix Inc (NASDAQ:EBIX) is even more impressive having shown staggering revenue growth (42.01%!) while operating outside of the consumer discretionary realm. It’s also a niche (software services) within another niche (insurance), which creates entrenchment from competition.
While you shouldn’t buy Ebix Inc (NASDAQ:EBIX) for this reason alone, I personally prefer businesses that aren’t reliant on consumer spending yet are still vital to their industry.