Small Cap Stocks Considered Undervalued as the Sector Surges

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We have identified 17 small cap stocks in the S&P 600 Small Cap index that have met stringent financial criteria

MarketWatch | December 5, 2016: Do you think it’s too late to invest in small cap stocks, which have rallied 12% in the three weeks since Donald Trump won the presidential election?

We have identified 17 companies in the S&P 600 Small Cap index that have met stringent financial criteria and are trading at price-to-earnings values that are lower than that of the index.

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The index traded for 19.8 times weighted consensus 2017 earnings estimates, among analysts polled by FactSet, as of the close on Nov. 28. That was up from 17.5 a year earlier. In fact, the index hasn’t traded so high relative to the following year’s earnings estimates since 2002.

That is why jumping into a small-cap index fund, such as the SPDR S&P 600 Small-Cap ETF   might be a rather risky choice for you today.

Screening small-cap stocks for ‘quality’

Starting with the S&P 600, we limited the group to stocks meeting these criteria:

  • Increased sales per share over the past 12 months. The per-share numbers reflect any dilution from the issuance of shares (to pay for acquisitions, for example), as well as any decline in the share count from buybacks.
  • Improved quarterly gross margin from a year earlier. The gross margin is a company’s sales, less its cost for goods sold, divided by sales.
  • Improved gross margin for the past 12 months from the previous 12-month period.
  • Positive net income margins this quarter and a year earlier, with the margin improving from a year earlier.
  • Positive net income margin over the past 12 months and previous 12-month period, with the margin improving.

The idea is to isolate companies that are increasing sales, while improving their pricing margins and overall efficiency.

A total of 41 companies met all the criteria. Consensus price-to-earnings ratios are available for 40 of the companies, and only 17 trade at forward price-to-earnings multiples below the index’s forward P/E of 19.8:

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