Battered by the pandemic, the stocks of small companies are ready to shine. For most of last year, the stock market was dominated by giant technology firms that seemed impervious to the coronavirus. But in the past three months, the Russell 2000 index, the benchmark for small-cap stocks, has bounced back with a 21.8% surge versus 11.5% for the S&P 500 index.
Reason: Small-cap stocks typically outperform after recessions because their earnings are more sensitive to economic changes than large-cap stocks. The nonpartisan Congressional Budget Office forecasts that US gross domestic product (GDP) is expected to reach pre-pandemic levels by the middle of 2021 as the country opens up again.
To help you get the most out of this stock market shift, Bottom Line Personal asked two top small-cap specialists—Robert Male, CFA, and Jamie Cuellar, CFA, of the Buffalo Small Cap Fund—to explain their focused strategy for finding winners for 2021 and beyond.
Focus on Long-Term Trends
All of the stocks we invest in tap into long-term secular trends, which are quantifiable changes in culture, demographics, technology and/or major industries that influence our lives and affect consumer and business buying habits. The trends, which held up well in the pandemic during 2020 and will benefit from an economic recovery, range from the voracious hunger for Internet bandwidth to the digitalization of health care to e-commerce as it matures and expands its base.
Once we identify a secular trend, we look for small companies that gain the most from these trends and have the following characteristics…
$500 million to $4 billion in market capitalization. However, we are willing to hold on to these companies as they become larger if they maintain the potential for fast growth, generally 15% annual earnings growth or more.
Significant competitive advantages, which allow them to weather downturns and take market share from rivals.
Manageable debt and strong free cash flow to sustain growth without having to raise additional capital.
Four long-term secular trends and the stocks we own in our fund that tap into them…
Trend: Precision Medicine
Advances in scientific understanding of the activity of genes in the body, including their role in certain diseases, have revolutionized the diagnostic-testing industry. Non-invasive tests give doctors the ability to quickly and cost-efficiently screen for diabetes, cancers and, most recently, COVID-19. Diagnostic testing is expected to grow 9% annually through 2027 and become a nearly $300-billion-a-year market. A precision-medicine stock that we own…
OraSure Technologies Inc. (OSUR) is best known for DNA testing kits. But the 33-year-old company also has pioneered an over-the-counter HIV test kit, urine testing to detect urological cancers and the first emergency-use authorizations from the FDA for an at-home COVID-19 sample collection kit. Recent share price: $11.08.
Trend: hunger for Bandwidth
By 2023, monthly US Internet traffic is forecast to be nearly double the current usage as Internet providers race to offer faster, more powerful and reliable broadband equipment, services and software. A communication bandwidth stock that we own…
Calix (CALX) manufactures broadband-access equipment and software that allows small US telecom providers to deliver the latest Internet and cloud services to residences without expensive upgrades. Calix also is a prime beneficiary of a new $20 billion program from the FCC to finance the construction of high-speed broadband networks for more than six million homes and businesses in rural communities. Recent share price: $42.23.
Trend: Maturation of E-commerce
The shift to online retailing seems to have taken over the world, but it’s still a new phenomenon. In the third quarter of 2020, e-commerce sales in the US accounted for just 14% of total retail sales. E-commerce–related stocks that we own…
Air Transport Services Group (ATSG) purchases used Boeing airplanes, refurbishes them and leases them out to shipping companies such as UPS and DHL. The company’s largest partner is Amazon.com’s “Amazon Air” delivery. It operates 31 Boeing 767s on Amazon’s behalf and plans to bring that total to 42 this year. Recent share price: $27.34.
The Lovesac Co. (LOVE) is best known for selling oversize beanbag chairs at showrooms around the country. Unlike most furniture companies, management optimized the business for e-commerce during the pandemic, vastly expanding future growth opportunities. For the quarter ending November 1, 2020, Lovesac increased sales and profits year over year by 44% and 57%, respectively, largely due to sales of its sectional couches, which are designed to come apart for personalized configuration, allowing the components to be shipped to consumers inexpensively. Recent share price: $61.75.
Trend: Digital Transformation of Health care
New technology is helping to streamline physicians’ work, optimize billing systems and lower costs. A health-care digital-transformation stock that we own…
Phreesia (PHR) makes software that allows about 50,000 physician offices, hospitals and clinics to manage their patient intake and coordinate patient billing. The company, which has partnered with dozens of major electronic-health record and payment networks, facilitates more than 50 million patient visits a year and $1.4 billion in payments. Recent share price: $62.05.