These small-cap stocks score highest when screened for quality
By Philip van Doorn
An updated screen highlights smaller companies that have shown high long-term returns on invested capital and are expected to grow quickly over the next two years
After years of dominance by the largest tech companies in the U.S. stock market, interest is spreading to overlooked companies that might be a better value for investors looking to diversify, lower their risk or do some bargain shopping.
Now it is time for another quality screen for small-cap stocks - looking back at long-term financial performance, but also looking ahead at expected growth for revenue and profits over the next couple of years.
Wednesday's Need to Know column: Druckenmiller may have done it again, loading up on small-caps before Great Rotation. Analysts say the move isn't done.
The Tell: This small-cap stock-market rally is remarkably unusual. That's why it has 'further to run.'
On Monday we summarized the market rotation, showing that investors had been leaning toward value stocks during recent trading sessions. We screened the Russell 1000 Value Index RLV to list stocks favored by analysts.
On Tuesday we screened the same index to list stocks with high dividend yields of companies expected to generate enough cash to be able to raise their payouts.
Today we are looking to small-cap stocks, which as a group might be considered value stocks because price-to-earnings ratios haven't soared as they have for large-cap stocks.
When money managers talk about small-cap stocks, they usually refer to the Russell 2000 Index RUT. But the Russell 2000 has no selection criteria. It is made up of the smallest 2,000 companies in the Russell 3000 Index RUA, which itself is designed to capture 98% of the U.S. stock market, also with no requirements for inclusion.
The Russell 2000 includes hundreds of unprofitable companies. So today we have screened the S&P Small Cap 600 Index SML, which has several requirements for companies initially to be included, such as four quarters of consecutive profits. Over the past 10 years, the Russell Small Cap 600 has returned 152% with dividends reinvested, well ahead of the 129% return for the Russell 2000, according to FactSet.
Before screening the small-cap stocks, take a look at weighted forward price-to-earnings ratios for three broad S&P indexes:
Index Forward P/E Forward P/E one year ago Current P/E to 5-year average Current P/E to 10-year average Current P/E to 15-year average
S&P 500 21.6 19.6 110% 119% 131%
S&P MidCap 400 15.7 14.7 100% 99% 102%
S&P Small Cap 600 14.9 13.0 99% 97% 100%
Source: FactSet
The S&P Small Cap 600 is the cheapest of the three indexes that make up the S&P Composite 1500 Index XX:SP1500 on a forward P/E basis. The S&P 500 SPX - the U.S. large-cap benchmark - is the most expensive, and its forward P/E ratio is high relative to its long-term averages. Exchange-traded funds that track the S&P Small Cap 600 include the iShares Core S&P Small-Cap exchange-traded fund IJR and the SPDR Portfolio S&P 600 Small Cap ETF SPSM.
The S&P Small Cap 600 is the least expensive of the three on this basis and is trading close to its long-term averages.
Screening the S&P Small Cap 600 for quality and growth prospects
Back in May, we screened the S&P Small Cap 600 for companies that had shown the best average returns on invested capital over the previous five years, among those that were expected to grow revenue and earnings more quickly than the index through 2025.
With the broad stock market performing so well since then, it is time to run the screen again, this time taking the revenue and earnings-per-share estimates through 2026.
For the entire S&P Small Cap 600, FactSet projects a weighted compound annual growth rate of 8.6% for revenue and 16.8% for EPS from 2024 through 2025.
A company's return on invested capital is its profit divided by the sum of the carrying value of its common stock, preferred stock, long-term debt and capitalized lease obligations. FactSet's quarterly ROIC calculation for a company is actually a 12-month look back. For five-year average ROIC, we looked at the numbers for the most recent quarter, then four quarters previous, and so on, to average the five most recent available four-quarter periods.
ROIC indicates how efficiently a company's management team has allocated the money it has raised from investors.
Here's how the new screen was done:
Among the S&P Small Cap 600, there were 269 companies covered by at least five analysts polled by FactSet for which revenue and EPS estimates were available through 2026 and for which data were available to calculate five-year average ROIC.We removed any for which EPS were negative or estimated to be negative for 2024, and any for which consensus 2025 or 2026 EPS estimates were negative. This brought the screen down to 227 companies.Among the 227 companies, there were 60 for which projected revenue CAGR from 2024 through 2026 exceeded the expected growth rate of 8.6% for the index.Among those 60 companies, there were for 43 which projected EPS CAGR from 2024 through 2026 exceeded the expected growth rate of 16.8% for the index.
We used calendar-year estimates for sales and EPS as adjusted by FactSet for a uniform set of data, because some companies' fiscal years don't match the calendar.
We sorted the remaining 43 companies by five-year average ROIC.
Here are the 20 with the highest five-year average ROIC - for comparison, the weighted average ROIC for the full S&P 600 has been 4.5%, according to FactSet.
Company Ticker 5-year average ROIC 5-year min ROIC 5-year max ROIC Two-year estimated revenue CAGR through 2026 Two-year estimated EPS CAGR through 2026 Catalyst Pharmaceuticals Inc. CPRX 36.0% 14.4% 56.7% 15.0% 24.8% Moelis & Co. Class A MC 25.8% -2.1% 57.4% 19.6% 73.8% Corcept Therapeutics Inc. CORT 23.6% 20.1% 30.4% 11.7% 36.2% Shutterstock Inc. SSTK 16.0% 4.7% 22.7% 13.4% 22.2% Calix Inc. CALX 14.7% -9.1% 48.6% 14.3% 86.8% StepStone Group Inc. Class A STEP 13.6% -1.9% 32.6% 20.3% 27.8% Palomar Holdings Inc. PLMR 12.8% 3.5% 19.3% 13.6% 19.9% MYR Group Inc. MYRG 12.8% 8.1% 15.6% 10.5% 23.7% CarGurus Inc. Class A CARG 12.1% -15.4% 38.6% 10.1% 18.4% Gogo Inc. GOGO 10.6% -12.4% 34.8% 14.9% 32.6% SPS Commerce Inc. SPSC 10.5% 9.7% 11.1% 14.6% 19.7% Advanced Energy Industries Inc. AEIS 9.9% 5.7% 13.6% 11.0% 38.1% Astrana Health Inc. ASTH 7.9% 5.6% 11.9% 20.8% 25.4% Staar Surgical Co. STAA 7.6% 3.9% 11.1% 17.4% 42.1% Triumph Financial Inc. TFIN 7.6% 3.3% 11.2% 15.4% 98.6% Mr. Cooper Group Inc. COOP 7.5% 2.5% 15.5% 10.0% 20.6% Dycom Industries Inc. DY 6.2% 0.5% 12.4% 9.6% 17.7% Goosehead Insurance Inc. Class A GSHD 5.4% 1.2% 12.4% 31.2% 46.0% Pacira Biosciences Inc. PCRX 4.8% -0.7% 16.8% 9.9% 24.4% Ichor Holdings Ltd. ICHR 4.5% -5.9% 9.1% 9.8% 142.2%
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