10 Small-Cap Stocks to Buy From Some of America’s Best ETFs

small-cap stocks to buy - 10 Small-Cap Stocks to Buy From Some of America’s Best ETFs

Source: Shutterstock

It seems like ages ago that I wrote an article about possible small-cap stocks to buy. However, it turns out the last piece I did was in early August. 

The S&P SmallCap 600 Index was getting pummeled at the time, down 11.8% for the year through Aug. 7. This was in comparison to a 3% return for the S&P 500. Almost two months later, the small-cap index has only seen its returns get worse; it’s now down -15.5% year to date (YTD) through Sept. 30. By comparison, the S&P 500 is up 4.7% over the same nine months.

Tech stocks like Apple (NASDAQ:AAPL) have been the story of the senior index’s year so far despite the recent correction. 

The farther small-cap stocks fall, the greater opportunity investors have to ride them all the way back up. The last time smaller stocks led the Callan Periodic Table of Investment Returns was in 2016. Before that, it led all asset classes in 2013 and 2010. Having not led since 2016, it’s time they deliver some market-beating performance.

To select my 10 small-cap stocks, I’m picked one U.S.-listed stock from the top 10 holdings of 10 of the largest exchange-traded funds with the words “small-cap” in the name.

  • Generac Holdings (NYSE:GNRC)
  • Teladoc Health (NYSE:TDOC)
  • Five Below (NASDAQ:FIVE)
  • Stamps.com (NASDAQ:SMTP)
  • Pool Corp. (NASDAQ:POOL)
  • TopBuild (NYSE:BLD)
  • UFP Industries (NASDAQ:UFPI)
  • Chegg (NYSE:CHGG)
  • L Brands (NYSE:LB)
  • Sunrun (NASDAQ:RUN)

At the end of the day, it ought to provide you with an excellent long-term portfolio.

Small-Cap Stocks to Buy: Generac Holdings (GNRC)

small pig figurine on top of short stack of coins next to large pig figurine on top of large stack of coins. represents small-cap stocks to buy
Source: Shutterstock

When Hurricane Dorian came around my part of the world in September 2019, I couldn’t help notice how many Generac ads there were on television for its backup generators. Talk about making a product ideally suited for hurricane country. 

Years ago, I can remember thinking that Generac wasn’t going to be all that and a bag of chips. I was very wrong in my assessment. Over the past 10 years, GNRC stock has had an annualized total return of 30.8%, about 2.5 times the U.S. markets as a whole. 

In January, I suggested that Generac could double in price for a second consecutive year. 

“As North America’s electrical grid ages, the number of power outages increases. Clearly, I’m not the only person noticing Generac’s products on TV. And, as a result, Generac’s raised its sales growth for the entire fiscal year,” I wrote on Jan. 7.  

Up 106% YTD, it’s got an excellent shot.

Teladoc Health (TDOC)

teladoc health logo on a mobile phone screen
Source: Piotr Swat / Shutterstock.com

It’s been a wild ride for shareholders who bought IPO shares of the telehealth company in July 2015. In the five years since going public, those shareholders still holding are sitting on unrealized capital gains of 1,058%. 

In early August, Teladoc announced that it would merge with Livongo Health (NASDAQ:LVGO) in a deal valued at $18.5 billion. At the time of the announcement, it was the third-largest acquisition of a U.S. public company.  

Together, the two digital health companies will have an enterprise value of $37 billion, with Teladoc shareholders owning 58% of the merged entity. Investors didn’t like the deal when it was announced, which shows in its performance. It’s down 12% in the two months since. 

But given how far TDOC stock had come at the time of the deal, its correction likely had more to do with valuation issues than corporate culture concerns or integration problems.

In early January, I said that shorting TDOC at $100 was a really bad idea. Now that it has more than doubled, I’m prepared to say that it remains a really bad idea. This is a company that could be a gamechanger in the healthcare industry. 

Five Below (FIVE)

storefront of a five below (FIVE)
Source: Jonathan Weiss / Shutterstock.com

Like many of the stocks in the top 10 holdings of the largest small-cap ETFs, Five Below’s market capitalization of $7.1 billion is much higher than the traditional definition of a small-cap stock, which are stocks between $300 million and $2 billion. 

No matter. It’s in the top 10 holdings of the Schwab U.S. Small-Cap ETF (NYSEARCA:SCHA) and I like how the discount retailer operates, so I’m going to run with it just the same.  

In June, InvestorPlace’s Tezcan Gecgil suggested that Five Below’s stock could come under pressure around its earnings report because much of the good news on the economy reopening was already priced into its stock. 

Since then, Five Below’s reported stellar first-quarter and second-quarter reports. Its stock is up 21% from June through September. 

In August 2018, I argued that FIVE was a retail stock worth buying after it reported its earnings. I’ve also called it one of the best stocks to own for the next decade. It’s gone relatively sideways in the two years since, but for my money, it’s one of the best-run retailers in the country.   

Stamps.com (STMP)

the stamps.com (STMP) logo on a sign outside of a corporate building
Source: Michael Vi / Shutterstock.com

One of the top 10 holdings of the SPDR S&P 600 Small ETF (NYSEARCA:SLY), which tracks the performance of the S&P SmallCap 600 Index, the little brother or sister of the S&P 500, Stamps.com has had a tremendous year on the markets. 

Up 217% year to date, it’s been on a bit of a roller coaster the last five years. So if you bought STMP stock five years ago, your annualized total return is 26.6%. If you bought two years later, your annual return drops to 5.9%, and if you bought a year ago, you’re sitting on a 223.6% return. 

Timing is everything in investing. Long term, however, you ought to do well holding the $4.3 billion market cap. That’s because its shipping solutions for businesses small and large will likely never go out of style. 

I recommended STMP in August 2017, suggesting that the momentum stock would continue to rule the day over value stocks. In hindsight, I know that didn’t happen and it fell all the way back to $34 in May 2019. 

I hope you were one of the smart ones to buy it while it was done. I continue to like it over the long haul.  

Pool Corp. (POOL)

businesswoman drawing large fish eating small fish to represent large-cap stock index funds
Source: Shutterstock

Pool is the largest holding in the iShares MSCI USA Small-Cap Min Vol Factor ETF (Cboe BZX:SMMV), an ETF that tries to deliver outsized returns with potentially less risk. Over the past five years, POOL has delivered an annualized total return of 36.5%, almost three times the U.S. markets’ performance as a whole. 

In mid-September, I recommended the distributor of pool products as a stock to buy to ride out the pandemic that would also deliver for you once the world returns to normal. Up more than 54% year to date, investors have realized that a pool’s a nice thing to have if you’re not leaving your own property anytime soon. 

It’s got such a great business and yet it’s still not in the S&P 500. Well, it ought to be, and I said so in April. With a market cap of more than $13 billion, it has clearly moved into the mid-cap category, but I say you buy the best stocks, regardless of pre-defined limitations. 

TopBuild (BLD)

a tiny man with boxing gloves having defeated a much larger man who is knocked out on the ground
Source: Shutterstock

A year ago, InvestorPlace contributor Louis Navellier recommended TopBuild, a company that distributes and installs insulation and other building products. It was one of seven businesses operating in the industrial sector. Up 72% over the past year, BLD was one heck of a call by my colleague. 

Now, it seems like the housing market is so hot that America will run out of new houses within months.

“Buyers are willing to pay more for a house than I’ve ever seen — I’m talking $30,000 to $50,000 over the listing price,” one Baltimore real estate agent told Redfin recently. “They’re desperate because homes are flying off the market so quickly. I’m selling all of the homes I’m listing within three days.” 

New homes need insulation. So, even though a shortage is never good, it’s better than the alternative — a surplus. With low rates and an America inclined to be homebodies for the next year or more, like Pool, TopBuild will continue to reap the rewards of a changing housing market.

In the second quarter, TopBuild’s sales fell by 2.1% as Covid-19 led to project delays. Expect it to catch up in the second half of 2020. As margins continue to expand, BLD ought to keep moving higher.

UFP Industries (UFPI)

a journal that says "Small is the new BIG" to represent small-cap stocks in index funds
Source: Shutterstock

In the middle of the pack when it comes to UFP Industries’ position in the top 10 holdings of the Avantis U.S. Small Cap Value ETF (NYSEARCA:AVUV), the seller of lumber to retailers, industrial businesses, and construction companies is definitely benefiting from the surge in home improvement in recent years. 

Over the past five years, shareholders have achieved an annualized total return of 24.9%, almost double the entire U.S. markets. 

In August 2019, the company announced that it would change its name from Universal Forest Products to UFP Industries to reflect its business better. The name became official on January 2. 

“We are not just a forest products or wood company anymore. Over the years, we have evolved from a lumber wholesaler to a mixed materials manufacturer and solutions provider serving thousands of business customers,” said CEO Matthew J. Missad in January. 

“Our new segments — UFP Retail, UFP Construction and UFP Industrial — will be much more focused on their individual markets, and with the leadership teams now in position, we expect more speed to market, better product and customer alignment and more efficient capital utilization.”

Look for it to continue to grow sales and earnings at a stable, if not spectacular, rate. In this case, slow and steady does win the race. 

Chegg (CHGG)

Chegg (CHGG) logo on the company's web page magnified by a magnifying glass
Source: Casimiro PT / Shutterstock.com

Chegg is a top 10 holding in the iShares Morningstar Small-Cap Growth ETF (NYSEARCA:JKK) with a 1.03% weighting. Considering there are 236 holdings in this ETF, the provider of online tutoring, textbook rentals, test preparation services, and many other services high school and college students require to perform at their best during their scholastic careers. 

I’ve liked Chegg for some time. In July 2019, I included it in a list of seven stocks to buy that make students’ lives easier. At the time, I said, “Chegg might not be profitable just yet, but it will be. Buy in now while its shares are still affordable.”

Flash forward a year. CHGG stock is up over 100%. As for those profits, it reported GAAP net profits of $10.6 million in its most recent quarter ended June 30, up 630% from a $2 million loss a year earlier. In 2020, it expects sales of at least $605 million with adjusted EBITDA of at least $190 million for a 31% margin. 

I expect business to continue to bloom as students everywhere move online for their educational underpinnings.  

L Brands (LB)

Source: mysirikwan / Shutterstock.com

It’s hard to believe that L Brands, the owners of Victoria’s Secret, PINK, and Bath & Body Works, is held by a small-cap ETF — it is the third-largest holding of the iShares Morningstar Small-Cap Value ETF (NYSEARCA:JKL) — but that’s how far the former retailing conglomerate has fallen. 

If you bought LB stock at the beginning of the year, you’re sitting pretty, up 78% YTD. That tells a much different story than those long-term shareholders who’ve seen the company’s market cap shrink dramatically as American Eagle’s (NYSE:AEO) Aerie brand has continued to take market share from Victoria’s Secret. It hasn’t helped that a lot of executives have left the company as a result.  

The reality is that most of the value in L Brands lies with Bath & Body Works, which continues to generate huge profits for the company. That’s why it’s working on splitting up the two businesses. In the second quarter, the division had operating profits of $326 million from $1.2 billion in sales. Meanwhile, Victoria’s Secret lost $140 million from $978 million in sales. 

Throughout this ordeal, management has managed to grow free cash flow. Despite the gains in 2020, it’s still cheap. 

Sunrun (RUN)

The Sunrun (RUN) logo is displayed on a smartphone screen in front of an American flag.
Source: IgorGolovniov / Shutterstock.com

Renewable energy is one of those subjects that really fascinates me despite the fact I’m not a real tech person. I just like learning about companies that are making a difference in the world’s future.

Sunrun, the nation’s leading provider of residential solar services with more than 300,000 customers in 22 states, the District of Columbia, and Puerto Rico, is one of these companies. 

As the company says in its August 2020 presentation, it’s installing a new solar-powered energy system every two minutes. Founded in 2007, the need for solar power and the storage systems that come with them has accelerated in recent years as power outages have become more commonplace. 

Sure, over the life of a solar-powered system, you might save a few thousand, but for me, the real attraction is the clean energy created by those systems. 

I know it seems ridiculous that I would be recommending a stock that’s up 468% in 2020. Still, when you have a business with this kind of opportunity — only 3% of homes have solar power today — its current market cap of $10.4 billion seems like a starting point, not an endpoint. 

In July, Sunrun announced it would acquire Vivint Solar (NYSE:VSLR) in an all-stock deal for $3.2 billion. Once completed, the merged entity will have more than 500,000 customers. 

Can a million be far behind?

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2020/10/10-small-cap-stocks-to-buy-from-some-of-americas-best-etfs/.

©2023 InvestorPlace Media, LLC