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Small Cap Cautions

Anybody paying attention has noticed that small-cap stocks are doing very well. Many analysts believe this trend will continue through the entire year. This does not mean there are not risks you as an investor shouldn’t consider. With small caps right now the two most prominent risks have to do with high valuations and high debt.


High Valuations

Experts have started noted that small caps as a class are started to look overvalued. According to Barron’s the index is trading at about 28 times forecast earnings. In fact, when comparing the forward P/E ratios posted by the WSJ recently the Russell 2000 was trading at about 27 times forward earnings and the Nasdaq 100 was trading at roughly 21 times forward earnings. By comparison the S&P 500 is only trading at 19 times forward earnings.

High Debt

Thanks to a decade of extremely low interest rates many small caps are carrying huge debt loads. Stock prices are up to some degree thanks to share buybacks and expansion – all courtesy of cheap money. Unfortunately, none of us has much to do with the underlying operation of the companies. Barron’s notes that the average return on assets (ROA) for small caps is slightly over 2% which is down by 33% since 2012.

Lack Of History

Small companies are typically newer companies. This means they have not had time to establish themselves as solid performers in their space. These companies grow faster due to that fact, but they also fall faster for the same reason. In a nutshell, small, newer, less well-established companies are a bigger risk than larger more well-established companies. One potential ray of sunshine comes from the fact small caps are not as well researched as large caps or even midcaps. They are therefore more likely to be mispriced by the market, representing opportunity to the savvy investor.

Trump And Small Caps

President Donald Trump’s recently passed tax plan that lowers corporate tax rates plus aggressive deregulation and moves to return production and jobs back to the U.S. could be a real boost for small caps. This contrasts with large companies with greater international presence that won’t benefit as much from some of Trumps tax moves. The main question has to do with how successful the Trump administration will be in meeting his business-friendly campaign promises.


Projected Small Cap Winners For 2018

There are clearly small cap companies that will be overall winners in 2018 just like there are winners every year. Among those identified by some experts are Axon Enterprises (NASDAQ:AAXNC) which used to be called TASER International. Axon had a bit of a bear year last year but is expected to do much better in 2018. Innoviva Inc. (NASDAQ:INVAC) makes inhaled drugs for asthma and COPD and is projected to show 32% growth this year.

Axcelis Technologies Inc. (NASDAQ:ACLSC) serves chipmakers with its Purion Ion Implanter. This tech-related small cap is thought by analysts to be undervalued by 32% making it a potential positive play this year. Craft Brew Alliance Inc. (NASDAQ:BREWC) is one of the more mature players in the craft brew movement. Some experts believe the movement is about played out. Others believe it’s here to stay and that Craft Brew is just getting started. Finally, Crocs Inc. (NASDAQ:CROXC), maker of Crocs shoes is another company that some consider a fad from yesterday. Thanks to growth opportunities in Korea, China and Japan, along with sales growth in the U.S., however, some experts think this shoemaker is poised to take off in 2018.

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