Small-company stocks look expensive as a group, and their performance has underwhelmed this year. But that's no reason to ignore all of them, because many small-company stocks are bargains.
A company's size is generally measured by its stock market value, or the cost to buy all of its outstanding shares. There's no set cutoff between large companies and small, because the market's value changes over time, but at the moment, the S&P 500 index of large companies has a median market value of just under $11 billion, versus about $650 million for the S&P SmallCap 600 index.
Investors have done better in small-company stocks over the past five years, but this year, large companies have outperformed, and there's reason to believe that will continue. The S&P 500 trades at 13 times trailing operating earnings, and the SmallCap 600, closer to 20 times earnings. Even considering the faster earnings growth of small companies, that's a hefty premium.
That's reason enough for index investors to favor large-company funds over small-company ones, but for stock pickers, some small companies hold plenty of appeal. Over 35% of the small-company stock universe trades below 10 times forecast earnings, according to a Wednesday report from Bank of America Merrill Lynch.
That's because the small-company universe is diverse. The S&P 600 index, for example, counts as members both iRobot (IRBT), a fast-growing maker of home and industrial robots whose shares fetch 27 time earnings, and Dean Foods, America's largest seller of milk, whose shares are half as expensive. So while investors would do well to lighten up on broad small-cap bets, there's still reason to shop for individual good deals.
Below are listed three small companies with healthy sales growth and modest valuations.
Market Value: $1.6 billion
Forward P/E: 8.1
Vegans might want to skip ahead. Darling International (DAR) is in the rendering business, which is to say, it turns the scraps slaughterhouses can't use into fat- and protein-based products like animal feed and biofuel. It also cleans grease traps for restaurants. Future biofuel mandates in Europe and Brazil bode well for demand, and rising world food demand favors Darling's feed products. Nearly a year ago Darling bought rendering rival Griffin for $840 million. Analysts say the deal has added to profits right away, and that it gives Darling cost-cutting opportunities and a nationwide reach for its grease trap business, which should help it win more business from large chain restaurants.
Market Value: $792 million
Forward P/E: 14
Cal-Maine (CALM) is America's largest egg producer (its chickens are, at least), providing 18% of domestic consumption. Egg prices have jumped, but feed prices have reached record levels, so while Cal-Maine's sales are expected to increase 16% during its current fiscal year, which runs through May, its earnings per share are expected to increase about 6%. Over the long-term, analysts say the company should benefit from rising demand for specialty eggs, such as those with added heart-healthy fats, which fetch higher prices. The stock's dividend yield is higher than it might seem. Last quarter's payment was puny, but the company has a policy of paying one-third of its profits in dividends. Based on the current price and projected earnings, shares are expected to yield nearly 5% over the next year.
Market Value: $1.3 billion
Forward P/E: 13
Netgear (NTGR) makes routers, switches and storage devices for home and business use and for use by cable service providers. Last quarter the company's sales increased 28% from a year earlier and its adjusted earnings per share rose 86%. Management says increased use of tablets and mobile devices is driving demand for home wireless networks in the U.S. and Europe. The higher sales also reflect 22 new products introduced during the third quarter, including devices that let users access home hard drives with their mobile phones and new gadgets for streaming online video to television sets. Netgear is debt-free with cash equal to about one-quarter of its stock market value.