Even with Monday’s sharp bounce, the Russell 2000 Index remains in the hole to the tune of 6% since its early-March peak. That’s even worse than the Nasdaq’s sizable pullback for the same time frame.
This weakness is made more alarming by the fact that, last Wednesday, the Russell 2000 Index moved below its pivotal 200-day moving average line for the first time since late-2012, sparking concerns that we may well be entering our next bear market.
As is so often the case, however, the market’s activity of late has been more random and coincidental than rational or calculated. Translation: Don’t read too much into the pullback from small-cap stocks. In fact, that pullback appears to have created some strong buying opportunities among the Russell 2000’s constituents. Here are four such small caps that bargain-hunters may want to consider first.
Portfolio Recovery Associates (PRAA)
For better or worse, collecting bad debts is a business that will never go out of style. That’s why Portfolio Recovery Associates (PRAA) is a solid all-weather play, particularly after shares of PRAA stock sank nearly 25% between October and February. Shares have made a modest recovery effort since then, but most of the rebound meat is still left on the bone.
The ironic risk here is if the economy tanks so badly, even debt collectors struggle simply because the money to repay loans just isn’t in consumers’ hands, as was the case between 2006 and 2009. As long as the economy remains stable, however, Portfolio Recovery Associates is plenty capable of maintaining its double-digit earnings growth rate, qualifying it as one of the market’s better small-cap stocks.
Marlin Business Services (MRLN)
Marlin Business Services (MRLN) finances equipment purchase and equipment leases for small businesses — photocopiers, computers, and the like. It’s not a riveting business, but it’s a reliable business as long as the economy is humming like it is now.
So why did MRLN stock get cut nearly in half earlier in the year even though other small-cap stocks didn’t? Good question — the answer still isn’t clear. That may be why shares have finally perked up the last couple of weeks. The recovery may also have something to do with the fact that the forward-looking P/E of 12 for a steady-Eddie grower like Marlin Business is a bargain.
Hercules Technology Growth Capital (HTGC)
Ever wanted to invest in small caps that aren’t publicly-traded? Hercules Technology Growth Capital (HTGC) is one way of doing so.
The private equity/venture capital fund currently backs 270 companies, ranging from Achronix Semiconductor to online game developer WildTangent. HTGC has a solid history of incubations too, with 74 exits of portfolio companies — once they were ready to sell — since the fund’s inception in 2004. It’s simply one of the better technology and life-science VC names that come in a publicly-traded wrapper.
The 17% pullback over the first quarter of the year had less to do with the company’s portfolio and more to do with the market’s mood, and now that the broad market is easing up, the market’s mood regarding Hercules Technology Growth Capital looks poised to improve.
Multimedia Games (MGAM)
With the stock down more than 13% since early March, it would be easy to assume Multimedia Games Holding Company (MGAM) was headed for a nasty earnings report at the end of April. The market was wrong, however. MGAM posted a 25% increase in revenue for the quarter, and a 28% improvement in earnings … and that was before the acquisition of PokerTek (PTEK). Bringing PokertTek into the fold will almost assure a fourth straight year of revenue and income growth.
And it hasn’t been chump-change growth either. Once the company finally shook off the recession, the top line has grown from 2010’s $118 million to last year’s $189 million. Annual profits have swelled from $2.63 million to $35 million during that time for Multimedia Games Holding Company; that’s a growth rate most other small cap stocks can only envy.
It’s still not a cheap stock, even with the recent weakness, priced at a trailing P/E of 22.3. But plenty of earnings beats and a double-digit growth rate make the premium worth it … especially after the stock’s multi-month nap.
Bottom Line for Small-Cap Stocks
The rhetoric has soured on small-cap stocks, and that pessimism has materialized in the form of a severe slide in the value of the Russell 2000 Index. Even Janet Yellen and Federal Reserve Governor Daniel Tarullo have joined the discussion, suggesting last week that valuations for small caps were too high for our own good. That was the day after the index closed under the 200-day average, and the day before the bears put some distance between the long-term moving average and the Russell 2000.
While it’s all unnerving at first glance, far more often than not, the right time to be bullish is when everyone else is bearish. We were due for a pullback, and we got one. End of story. The economy is still in growth mode, and earnings remain on the rise. Despite Yellen’s concern — perhaps because Yellen made a point of voicing an oddly-specific concern — we should take it as a contrarian clue that small caps have already hit their short-term bottom.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.