A rising tide lifts all boats.It's one of the great sayings about the impact of a bull market. But what this pearl of wisdom fails to convey is how different groups of stocks respond to that movement in different ways.
That has once again been on display in the strong market of 2013. The S&P 500 Index is up 19% on the year, but the iShares Core Small Cap ETF (NYSE: IJR) has gained an outsize 28%. With the market going "risk-on" this year, small-cap stocks and growth stocks have logged a strong performance.
Those big gains shouldn't come as a surprise to investors who have been following small caps for the past dozen years. While the S&P 500 is up just 23% since 2001, small caps have returned an eye-popping 235%. Take a look at the amazing divergence in the chart below.
There's no question that small caps are risky and can be very volatile. Inevitably, some will declare bankruptcy and go out of business. But in the long run, these smaller companies have tremendous upside that most blue-chip stocks have long outgrown.
But just because small caps have been surging and offer the potential for outsized gains doesn't mean investors have to pay ridiculous valuations for a chance at growth. In fact, there are plenty of small cap, growth stocks trading deep into value territory. Below is a list of 7 of the best.
From the group, I have chosen to highlight Cash America (NYSE: CSH) because shares are being artificially compressed due to overblown regulatory concerns and Sonic Automotive (NYSE: SAH) because of its unique combination of growth and value.
A specialty financial services company that offers pawn and payday loans, Cash America owns and operates more than 1,000 locations in the United States and Mexico. In the slow-growth economy of the past four years, Cash America has been surging, up 183% since bottoming out in the spring of 2009. But in spite of those impressive gains, analysts remain optimistic on growth, calling for earnings growth of 17% in 2014.
The company's forward price-to-earnings (P/E) ratio of just 11 times is a big discount for a small-cap, growth stock. That lower valuation has partially been driven by ongoing concerns about a restrictive regulatory environment in which lawmakers are attempting to crack down on high-interest lending. But that has yet to have a material impact on the company's business, as earnings continues to grow. And as a market leader in a growth industry with high margins and barriers to entry, Cash America is a buy anywhere below $50.
While Tesla (Nasdaq: TSLA) has been stealing all the headlines in the auto industry, a group of little-known dealerships has quietly been surging behind the scenes. That includes Sonic, up a market-crushing 73% in the past two years. Looking forward, Sonic -- the owner of more than 100 dealerships in 14 states -- still has plenty of upside.
Earnings are expected to grow 16% this year, 13% next year and an average of 24% annually in the next five years. That strong earnings growth has Sonic trading deep into value territory in spite of big gains on the chart. The company's forward P/E of 12 is a 25% discount to its peer average of 16. On the chart, shares have been pressuring the key $24 level for most of the year and appear to be in position to break out. Sonic is a buy below $27.50.
Risks to Consider: Small caps are typically much more volatile than their large cap counterparts. In regard to Cash America, regulatory uncertainty remains a concern. Although that has yet to have a real impact on earnings, new legislation or regulatory initiatives should be watched closely.
Action to Take --> Small caps continues to outperform the S&P 500. But even though these high-growth companies have seen big gains, there are still plenty of small caps that look undervalued. From the group, consider Cash America because shares are being artificially compressed due to overblown regulatory concerns and Sonic Automotive because of its unique combination of growth and value. That makes Cash America is a buy anywhere below $50 and Sonic is a buy below $27.50.