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All Contents © 2018The Kiplinger Washington Editors
By Will Ashworth
| November 30, 2018
Shark Tank investor Kevin O’Leary believes that small-cap stocks are the perfect investment over the next few years as trade issues get sorted out and tax cuts deliver their full impact.
“I say there is 20% more cash to come to these companies in the next 24 months through tax reform, so I am staying on this trade,” O’Leary told CNBC back in August. “I am betting they continue to outperform not only the S&P 500, but maybe even emerging markets. There is tremendous value to be unlocked in small caps in America.”
That call hasn’t exactly looked great in the short-term, with the small-cap Russell 2000 Index dropping 12% over the past three months. But that’s the nature of the beast – higher risk, higher reward – so I still couldn’t agree with O’Leary more.
While certainly more volatile and risky, small caps (typically between $500 million and $2 billion in market value, though definitions vary across information providers) add the potential for explosive growth that many established blue-chips simply can’t match. After all, it’s much easier to double revenues from $1 million than to do the same from $1 billion – and the same kind of performance expectations tend to hold true for shares of smaller companies versus larger ones.
Here are the 10 best small-cap stocks to buy for 2019. Each has high potential to beat the S&P 500 for at least the next 12 to 24 months.
Data is as of Nov. 29, 2018.
Market value: $1.2 billion
Sector: Consumer discretionary
Analysts’ opinion: 6 buy, 0 overweight, 8 hold, 0 underweight, 2 sell
A hot economy goes a long way to helping the restaurant industry deliver strong earnings. Nowhere is this truer than at BJ’s Restaurants (BJRI, $55.39), whose locations include regular restaurants (BJ’s Restaurant & Brewhouse) and restaurants with breweries (BJ’s Restaurant & Brewery). Its stock has returned 53%, including dividends, in 2018.
In the first six months of fiscal 2017, BJ’s Restaurants had negative same-store sales of 1.4%. A year later it reported positive same-store sales of 4.9% – that’s 6.3 percentage points higher! A big part of the increase is due to stronger foot traffic to its 200 locations across the U.S.
The formula for success isn’t easy, but surprisingly simple: Deliver a strong offering to your customers in a strong economy, then let nature take its course.
“As we move into the second half of 2018, we remain focused on driving sales and traffic and taking market share in the casual dining segment of the restaurant industry,” BJ’s Restaurant CEO Greg Trojan said in the company’s Q2 2018 press release. BJRI posted a beat on both the top and bottom lines for Q3, too.
Piper Jaffray analyst Nicole Miller Regan believes restaurant chains that are focused on the U.S. market and operate company-owned locations should outperform in 2019. BJ’s Restaurants happens to be both of those. Look for it to slow its store openings in the next year, opting to focus on its operations and developing innovative new menu items.
Market value: $2.4 billion
Analysts’ opinion: 5 buy, 0 overweight, 3 hold, 0 underweight, 0 sell
Minnesota-based H.B. Fuller (FUL, $47.74) has been manufacturing adhesives for numerous commercial applications since 1887, when it offered up Fuller’s Premium Liquid Fish Glue. No joke.
The company’s 2020 plan, however, has it transforming into a focused business that only participates in the highest-margin, highest-growth markets.
As part of H.B. Fuller’s 2020 plan, it expects annual organic growth of 4.5% by 2020, revenue of $3.4 billion (48% higher than its 2017 sales of $2.3 billion), EBITDA margins of almost 18%, along with the repayment of $600 million of its $2.3 billion in outstanding debt. The company’s EBITDA was just $268 million in 2016, when the company first announced the 2020 plan. In 2018, after boosting its goals, it now expects to deliver $605 million in EBITDA by 2020.
Once H.B. Fuller meets all of its 2020 plan objectives in three years, it expects to have a market cap of at least $5 billion – more than double where it is today.
Market value: $4.2 billion
Analysts’ opinion: 1 buy, 2 overweight, 2 hold, 0 underweight, 0 sell
Insperity (NSP, $98.32) was founded in 1986 as a professional employer organization providing outsourcing of various management and human resources tasks such as payroll, benefits and workers’ compensation to small- and medium-sized businesses in the U.S.
Originally called Administaff, it changed its name to Insperity in early 2011 to better reflect the changes to the services it offers. Today, Insperity’s Workforce Optimization solution helps more than 100,000 businesses operate more efficiently.
CEO Paul Sarvadi co-founded the company and took it public in January 1997. Shareholders who bought the IPO shares ($17, or $2.13 adjusted for splits) have done exceptionally well, generating an annualized total return of more than 19% throughout almost 22 years as a public company. By comparison, the SPDR S&P 500 ETF (SPY) has a 22-year annualized total return of 7.9% – less than half Insperity’s return over the same period.
As CEOs go, Paul Sarvadi is one of the best in any business, not just the human capital management industry.
Market value: $2.7 billion
Analysts’ opinion: 3 buy, 1 overweight, 2 hold, 0 underweight, 1 sell
Iridium Communications (IRDM, $23.70) has the only mobile voice and data satellite communications network to span the world. It does this by linking together 66 Low Earth Orbit (LEO) satellites, which provide users high-quality voice and data connections anywhere on the planet.
Not content to rest on its laurels, Iridium is in the final stages of building Iridium Next – its second-generation satellite network that will provide users with higher speeds and bandwidth across the globe.
This next-generation network caught the attention of Amazon.com (AMZN). Iridium recently announced that it has joined the Amazon Web Services (AWS) Partner Network and is working with the cloud-computing and e-commerce giant to develop CloudConnect, a satellite cloud-based solution that will enable AWS customers to expand their Internet of Things coverage around the world.
Iridium has been growing steadily for years, and CloudConnect could keep the momentum going. In the second quarter, it grew commercial IoT subscribers by 25% to 576,000, 55% of its overall subscriber base. In Q3, that number reached 612,000 customers – and Iridium updated its full-year outlook for total service revenue growth and operational EBITDA.
Market value: $2.6 billion
Sector: Consumer discretionary
Analysts’ opinion: 4 buy, 0 overweight, 6 hold, 0 underperform, 0 sell
If there’s a stock that’s had a checkered past, Boston-based iRobot (IRBT, $93.90) – maker of the Roomba home vacuum – would be near the top of that list.
Shares are up about 22% year-to-date, but anyone who happened to buy around mid-2017 is sitting on zero gains right now. Like many small-cap stocks, IRBT is mercurial.
That said, iRobot’s Roomba robotic vacuum cleaner must be considered one of the most significant consumer technological advances over the past 25 years, right up there with Apple’s (AAPL) iPhone.
In 2012, robotic vacuum cleaners (RVC) accounted for 13% of the global vacuum cleaner market for products over $200 at retail. Today, RVCs account for 23% of the market, with sales growing by 22% compounded annually. Worldwide, iRobot has a 62% market share, with an astounding 85% share in North America. As smart homes become the norm, iRobot will continue to gain share.
IRBT isn’t cheap by any metric, including P/E (40) and price-to-cash flow (41). But it should grow into a more reasonable valuation as its revenues grow from the hundreds of millions into the billions.
Market value: $2.9 billion
Sector: Consumer staples
Analysts’ opinion: 2 buy, 1 overweight, 1 hold, 0 underweight, 0 sell
If you’re a believer in owner- and founder-led companies, few can match the success of J&J Snack Foods (JJSF, $155.48). CEO Gerald Schreiber bought this New Jersey-based snack food company out of bankruptcy for $73,000 in 1971 and has been running it ever since.
Its best-known brands include Superpretzel, Icee, Slush Puppie and Minute Maid frozen lemonade, but interestingly, one of the company’s private-label arrangements is with Newman’s Own, the charity that the late Paul Newman established in 1982 to sell food and beverage products. Fully 100% of the profits go to good causes.
J&J Snack Foods went above $1 billion in annual revenue for the very first time in fiscal 2017. This isn’t a high-growth business, but it is appropriate to label it a steady grower, compounding revenue at 6.2% annually over the past nine years.
Schreiber is the company’s largest shareholder at 20% of the company’s stock. At age 76, he doesn’t show any signs of slowing down, which is good news for long-time shareholders, who haven’t seen a down year in the past decade.
Market value: $3.3 billion
Sector: Health care
Analysts’ opinion: 9 buy, 0 overweight, 2 hold, 0 underweight, 0 sell
If you have aging parents, there’s nothing quite as important as finding good home healthcare for them. Parents want to retain their independence for as long as they possibly can. Home healthcare can be a crucial ingredient in providing this independence.
LHC Group (LHCG, $105.55) is a leading national in-home healthcare service provider in the U.S. with approximately 32,000 employees in 36 states working in partnership with more than 330 hospitals to provide care in-home and outside the home.
The company’s multi-channel growth strategy includes both organic initiatives to take market share as well as acquisitions to add to its geographic reach. Between 2013-17, LHC Group added $436 million in annual revenue through acquisitions. Over that same period, it has grown revenues by 23% compounded annually.
In April, the company completed its all-stock merger with Almost Family to make it the second-largest U.S. home health provider with annual revenue of $1.8 billion, second only to Kindred Healthcare at $2.5 billion. Its current service area captures about 60% of the U.S. population age 65 and older, providing it with significant opportunity to capture more of the in-home healthcare market.
Market value: $2.3 billion
Analysts’ opinion: 14 buy, 2 overweight, 7 hold, 0 underweight, 0 sell
Denver-based exploration-and-production small cap PDC Energy (PDCE, $35.43) has been simply battered by low oil prices, with the stock down 35% over the past three months. Yet over the same time period, the company only lost one “Buy” call (to an analyst who stopped coverage), and in fact had one of its other “Buys” upgraded into a higher-conviction call. Today, 16 analysts still say to buy the stock, seven say to hold it and none think PDCE is a sell.
Between the company’s Colorado and Texas acreage, PDCE had proved reserves of 453 million barrels of oil equivalent (MMBoe) at the end of 2017, 77% in the Wattenberg gas field in Colorado with the rest in West Texas’ Delaware Basin. The company has grown its proved reserves by 20% annually compounded over the past three years. And PDCE expects it will take 10 to 15 years to develop all its current development sites. This year, it should produce about 40 MMBOE and invest almost $1 billion in capital.
Most importantly, the company says it expects to generate cumulative free cash flow of more than $400 million between the second half of 2018 and the end of 2020. Considering PDC Energy hasn’t generated positive annual free cash flow over the past five years, $400 million over a 30-month period would be excellent news for shareholders.
Market value: $3.1 billion
Sector: Information Technology
Analysts’ opinion: 7 buy, 1 overweight, 7 hold, 0 underweight, 0 sell
Qualys (QLYS, $77.17) provides its clients with a cloud security and compliance platform enabling large and small enterprises to consolidate all their security and compliance solutions in one stack. This platform transforms a company’s security and compliance assets onto a truly cloud-based operation.
The company’s 10,000-plus customers include 46% of the Forbes Global 500. It generates 60% of its revenue directly through the end user and the remaining 40% through third-party partners. By 2021, its total addressable market is expected to grow to almost $21 billion, which should translate into Qualys growing its annual revenues by 20% for years to come.
Qualys has seen its annual revenues grow from $134 million in 2014 to $231 million in 2017. Of its enterprise customers (those businesses with more than 5,000 employees), 19% use four or more of the company’s solutions, up from 1% in 2015. Those who use more than four solutions spend more than five times what a customer does who uses just one solution.
More importantly, not only is Qualys growing the top line, but it has some of the best EBITDA margins among its security and software-as-a-service peers. That will keep its stock moving higher in 2019 and beyond. Analysts seem to increasingly agree, as the company has picked up four “Buy” calls in the past three months.
Market value: $594.0 million
Analysts’ opinion: 4 buy, 0 overweight, 3 hold, 0 underweight, 1 sell
As brand names go, it doesn’t get much better than Re/Max Holdings (RMAX, $33.80), the No. 1 seller of residential real estate in the world. According to the 2018 Franchise Times Top 200+ annual survey, Re/Max is the No. 1 ranked real estate franchise brand in the country and the 10th ranked franchise overall for the third consecutive year.
What makes the Re/Max agent-centric business model so exciting is that 66% of its annual revenue is recurring in nature, generating stable cash flow investors can count on. In 2017, Re/Max generated $61 million in free cash flow, or 60% of its adjusted EBITDA.
While the business is wholly franchised, 67% of its agents operate in company-owned regions in the U.S. and Canada. Those 56,293 agents represent approximately $2,600 a year in revenue to the company from continuing franchise fees, broker fees and annual dues. In the nine North American regions not owned by the company, the typical agent represents approximately $750 in annual revenue.
Re/Max plans to use some of its free cash flow to acquire those regions it doesn’t already own, thus generating even more recurring revenue.
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