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By Philip van Doorn
Past periods of low valuations have resulted in big comebacks for smaller companies
Small-cap stocks are trading near a two-decade low when compared to large-cap stocks. If the stock market recovers next year, as expected by many investment bank strategists, those smaller companies may fare better.
Below is a screen of analysts’ favorite small-cap stocks for 2023, drawn from the S&P Small Cap 600 index, which requires companies to be profitable for inclusion.
Big gap
After a stock market rally from mid-October to November, shares have been falling ever since. Recession fears are mounting and the Federal Open Market Committee is preparing for another rate hike on December 14.
Strategists at BNP Paribas led by Greg Boutle, head of US equity and derivatives strategy, reviewed 100 years of market crash data and concluded that investor sentiment would bottom out in 2023. years,” said Boutle.
That signals a recovery for the stock market as a whole, which could mean even bigger gains for small-cap stocks.
Here’s why: The forward price-to-earnings ratio of the S&P Small Cap 600 index is near its lowest point since late 1999 against the large-cap S&P 500:
Small caps averaged only slightly below the S&P 500, as indicated in the top right corner of the chart. They are now close to a low and only slightly higher than a year ago.
On the other hand, the weighted forward price-to-earnings ratio for the S&P Small Cap 600 Index is now 12.7, compared to 15.5 a year ago, according to FactSet. (The forward P/E for the S&P 500 is down from 21.4 a year ago to 17.2.)
Since the stock market can be expected to recover during a recession in anticipation of a fall in interest rates and a return to economic growth, investors can expect an accelerated recovery for small caps.
The best way to ride the small caps, if you expect a market recovery, might be to buy shares of an exchange-traded fund, such as the SPDR S&P 600 Small Cap ETF (SLY), the iShares Core S&P Small Cap ETF (IJR ) or the Vanguard S&P Small-Cap 600 ETF (VIOO).
Analysts’ favorite profitable small businesses
Some money managers benchmark their small-cap ETFs or mutual funds against the Russell 2000 Index, but that index is not selective. In fact, 40% of Russell 2000 companies were unprofitable for their most recently reported fiscal quarters. According to FactSet, only 22% of the S&P 600 was unprofitable.
Standard & Poor’s criteria for initial inclusion in the S&P Small Cap 600 Index include positive gains for the most recent quarter and for the sum of the most recent four quarters.
To continue with the idea of profitability, we screened the S&P 600 as follows:
Of the remaining 56 companies, these are the 20 with the most upside potential, based on consensus price targets:
Company Ticker Industry Share "buy" ratings Dec. 6 price Consensus price target Implied 12-month upside potential
ModivCare Inc. MODV Medical Transportation 100% $86.54 $145.83 69%
Ligand Pharmaceuticals Inc. LGND Pharmaceuticals 100% $67.83 $110.83 63%
Customers Bancorp Inc. CUBI Regional Banks 75% $30.08 $48.25 60%
Outfront Media Inc. OUT Real Estate Investment Trusts 83% $17.05 $27.00 58%
Smart Global Holdings Inc. SGH Semiconductors 100% $16.00 $25.17 57%
Pacira Biosciences Inc. PCRX Pharmaceuticals 80% $46.97 $72.90 55%
Adtran Holdings Inc. ADTN Computer Peripherals 75% $19.38 $29.40 52%
Talos Energy Inc. TALO Oil & Gas Production 86% $19.33 $28.83 49%
OptimizeRx Corp. OPRX Software 100% $19.09 $27.33 43%
Alarm.com Holdings Inc. ALRM IT Services 75% $48.55 $68.86 42%
Civitas Resources Inc. CIVI Integrated Oil 100% $59.72 $84.33 41%
MaxLinear Inc. MXL Semiconductors 92% $34.74 $49.00 41%
Dave & Buster's Entertainment Inc. PLAY Movies/ Entertainment 80% $36.20 $50.78 40%
Boot Barn Holdings Inc. BOOT Apparel/ Footwear Retail 92% $63.86 $89.27 40%
Vista Outdoor Inc. VSTO Recreational Products 75% $27.55 $38.29 39%
Digital Turbine Inc. APPS Software 100% $15.72 $21.84 39%
Innovative Industrial Properties Inc. IIPR Real Estate Investment Trusts 75% $118.05 $161.83 37%
Green Plains Inc. GPRE Chemicals 78% $31.81 $43.22 36%
Golden Entertainment Inc. GDEN Casinos/ Gaming 100% $42.36 $57.25 35%
Collegium Pharmaceutical Inc. COLL Pharmaceuticals 83% $22.40 $30.25 35%
Source: FactSet
Click on the tickers to learn more about a company or index in this article.
You should also read Tomi Kilgore’s detailed guide to the wealth of information for free on the MarketWatch quote page.
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Philip Van Doorn
(END) Dow Jones Newswires
10/22/12 1544ET
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