Small-cap stocks are the asset class of choice for numerous investors. And with good reason — smaller stocks have been shown to outperform their larger brethren over time, largely because they simply have more room to grow.
When a smaller company begins to show the kind of sizzling earnings growth and fundamental improvements that mark a best-of-the-best stock, the big guys tend to take notice. Wall Street firms scramble to cover and recommend the stock, and the large institutions begin to buy the shares. When that type of buying pressure is applied to a relatively small company, the stock can soar.
However, when picking smaller-cap stocks, it’s even more critical than usual to target the companies with the best fundamentals. Companies that fall short of expectations can see their stock ignored — or worse, pummeled by selling pressure from disappointed large-scale investors.
Fortunately, we have the proper tool to help us find smaller stocks with big fundamentals.
Addus Home Healthcare (ADUS) provides home- and community-based healthcare services to the elderly, as well as younger disabled individuals. Services include personal care, skilled nursing and adult daycare, with ADUS providing social activities, transportation and therapeutic activities. Addus has been seeing strong demand for its services as the population ages and more adults become disabled or critically ill. Earnings growth has averaged 25% during the past five years — and it’s accelerating. In its first quarter, earnings grew by more than 50%. ADUS was upgraded by Portfolio Grader to an “A,” or “strong buy,” back in November and has remained there as its fundamentals continue to improve. Institutions own less than 70% of these shares, so there is plenty of room for buying pressure to build and take the stock higher.
Erickson Air-Crane (EAC) occupies a unique niche in the aerospace markets. The company provides heavy-lift helicopter services for logging, firefighting, construction, infrastructure and government projects. It also manufactures heavy-lift aircraft from existing airframes. Earnings growth has been spectacular, with 70%-plus year-over-year improvement, and EAC posted a triple-digit positive earnings surprise in the previous quarter. Erickson Air-Crane debuted in Portfolio Grader in April as a “strong buy” and still commands the top “A” rating. Institutions own 30% of the shares, and when they begin to take note of Erickson’s powerful fundamentals, the buying pressure should quickly move the stock higher.
Alliance Finer Optics Products (AFOP) makes components used in fiber optic networks, including such things as connectors, splitters, couplers and amplifiers. The company is seeing strong demand for its products, and a couple months ago, AFOP reported that its Q1 earnings had doubled year-over-year. Alliance also raised its guidance for the rest of the year. The company has posted four consecutive positive earnings surprises, and investors are starting to take note of the strong fundamentals. The stock receives an “A” from Portfolio Grader, denoting a “strong buy” recommendation.
Just remember: Small-cap stocks are a high-risk, high-reward market segment. But you can amplify the reward and reduce potential risks by sticking to the highest-rated stocks.
Louis Navellier is the editor of Blue Chip Growth.