Why You Shouldn’t Ignore Smaller Tech Stocks

It doesn’t take a top-notch market expert to see what led the market on a furious rally in the aftermath of the Covid-19 selloff. In fact, you can’t help but notice that they happen to belong to the same sector.

I’m talking about names like NVIDIA (Nasdaq: NVDA), Advanced Micro Devices (NYSE: AMD), Amazon.com (Nasdaq: AMZN), PayPal (Nasdaq: PYPL), and others. Those names, by the way, happen to be four of the top-five performers in the S&P 500 this year. They’ve racked up healthy gains between 90% and 145%, respectively.

The tech group has absolutely dominated the market leaderboard this year. Apple (Nasdaq: AAPL), Netflix (Nasdaq: NFLX), Adobe Systems (Nasdaq: ADBE), and Saleforce.com (NYSE: CRM) are also in the top-ten, with year-to-date returns of 60% or more.

Keep in mind, that’s just within the realm of the S&P 500, home to the nation’s largest publicly traded businesses. While these heavyweights account for 80% of the market’s girth, they are only a fraction of the 7,000+ stocks trading on major U.S. exchanges.

I’m here today to tell you this: Ignore the other 6,500 at your own peril.

If You Thought Big Tech’s Rally Was Impressive…

Let’s look at the mid-cap space, which includes stocks with market caps between $2 billion and $10 billion. The top performer here is Novavax (Nasdaq: NVAX), a frontrunner in the race to develop a Covid-19 vaccine. The stock has delivered a jaw-dropping gain in excess of 2,000% this year.

nvax chart

Other big winners include Fastly (Nasdaq: FSLY), a provider of cloud computing infrastructure, Fiverr International (Nasdaq: FVRR), which runs an online marketplace for professional freelancers, and Overstock (Nasdaq: OSTK), a cryptocurrency developer. These three are sitting on massive gains of 279%, 430%, and 824%, respectively.

How about small-caps? Well, the tech sector claims many of the top spots here as well. But they are joined by a slew of others that are riding Covid tailwinds. It has obviously been a good year for hopeful biotechs such as Adaptimmune Therapeutics (Nasdaq: ADAP), while ongoing social distancing mandates are benefitting companies like Nautilus (NYSE: NLS). With more people exercising from home these days, shares of the fitness equipment maker have soared seven-fold.

But they haven’t kept pace with Waitr (Nasdaq: WTRH), which has spiked more than 1,000%. Clearly, this is a good time to be in the food delivery business. The company has just added grocery and alcohol delivery to its service repertoire – big potential growth drivers.

wtrh chart

What am I getting at here? Well, for starters, don’t be afraid to invest in smaller companies that aren’t yet household names. The top-performing small and mid-sized companies have been outrunning large-cap winners by as much as a 10-1 margin.

That’s a bit surprising, considering the Russell 2000 Index has lagged behind the S&P 500 by about 14% this year.

Second, the market is clearly separating winners from losers in this new Covid world. Those tailwinds I mentioned earlier might not be fading away anytime soon – even with a potential vaccine on the horizon. In fact, many of our forced lifestyle changes may prove to be permanent (telehealth, for instance).

And that’s exactly why this pandemic is seismically reshaping the investment landscape, toppling some industries, and thrusting others higher.

Ignore At Your Own Peril

Let’s get right to the point. If you don’t have any exposure to the tech sector, then your portfolio is probably hungry for gains this year. Sure, the market has also been feasting on anything with either “immune” or “therapeutics” in the name. But a high-tech diet has been the surest way for investors to stay well-fed.

Apple, Facebook, and Amazon may have led the charge to record highs, but many of their small and mid-sized counterparts are doing even better.

Plus, there are sound reasons why the investment community continues to propel these stocks upward. Even in the face of a global pandemic, many tech companies continue to post record earnings. Apple generated an unprecedented $16 billion in operating cash flow last quarter – with all 510 retail stores completely shut down – and dished out $3.5 billion in dividend payments.

According to FactSet Research, 94% of tech companies beat earnings estimates last quarter – tops among all sectors. Nearly two dozen have already released positive third-quarter guidance, also the highest of any sector. And the group as a whole is forecast to hike dividends by an average of 9%, trailing only the 10% for healthcare stocks.

Meanwhile, entire sectors of the economy (real estate, utilities, consumer staples, etc.) are underwater in 2020.

Just look at the T. Rowe Price Equity Income Fund (PRFDX), a portfolio anchor for thousands of 401(K) holders and other investors. The dividend-centric fund invests strictly in a diversified pool of undervalued stocks with generous payouts. Its $15 billion portfolio is heavy in banks, healthcare firms, industrial manufacturers, and other income producers, but noticeably underweight tech.

Year-to-date, PRFDX is down more than 15% — the worst showing in over a decade.

I suspect the fund will return to its winning ways in time. Still, it might continue to lag without more help from Silicon Valley. And that goes for you and me as well.

Action To Take

That certainly doesn’t mean it’s time to back up the truck and load up every software developer and cloud computing provider you can find. In fact, last month’s issue of High-Yield Investing carried a warning that some of these overheated stocks are overvalued and prone to a correction.

I stand by that. But… many investors (especially income hunters) have shied away from this group entirely. That’s not a wise approach either, as these integral businesses now constitute 30% of corporate America. Even for conservative investors, adding a few high-octane tech stocks to an otherwise low-beta portfolio can rev up performance.

P.S. In my most recent research report, I discussed why I think it’s time for investors to sell Apple.

That’s right. I know it sounds crazy. But the truth is, as I just showed you, there are much better choices out there for investors.

If you check out my latest research, you’ll understand why…