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The year 2016 will long be remembered for the great turnaround of small cap stocks. Small-cap stocks clearly emerged as the winners of 2016 after an impressive recovery in the second half of the year helped the major U.S. benchmarks to end the year on a strong note.
Factors including a Trump-induced rally, improving U.S. economy in the latter half of the year and a strong rebound in oil prices boosted stocks this year and are speculated to give a further boost in the near future. In this encouraging backdrop, investing in fundamentally strong small cap stocks might emerge as one of the lucrative options for the next year.
Performance of Small-Cap Stocks in 2016
After a tough time last year, small-cap stocks made a remarkable recovery this year. The Russell 2000 Index, which is broadly considered for measuring the performance of small-cap stocks, increased 18% this year following a 6.5% decline last year. In fact, this was the best yearly performance of the index in three years. It has also easily outperformed other major U.S. benchmarks.
The index’s gains this year were significantly higher than returns of 12.6%, 9.8% and 7.6% posted by the Dow, S&P 500 and Nasdaq, respectively. Moreover, the small-cap index significantly outpaced the major U.S. indexes during the post U.S. President election period. While the Dow, S&P 500 and Nasdaq gained 8.5%, 5.5% and 5.2%, respectively during the said time frame, the Russell 2000 index surged 14.3%.
Performance Comparison of Russell 2000 with Dow, S&P 500 and Nasdaq
Factors Boosting Small-Cap Stocks
Improving U.S. Economy
Small-cap stocks are believed to derive higher gains from an improving economy compared to their large- and mid-cap counterparts. Thus, it is likely that strong recovery witnessed in the U.S. economy during the second half of this year has played a vital role in boosting the small cap stocks.
Encouraging economic data including a two-year high GDP growth rate during the third quarter, 12-year high consumer confidence level, encouraging labor market conditions and expanding manufacturing and services sector also indicate that the economy is on a strong footing. This favorable backdrop also led the Fed to hike key interest rate for the first time in nearly a year.
Trump Induced Rally
Like the broader stock markets, small-cap stocks also benefited from positive investor sentiment, which in turn got a major boost following Trump’s victory in the U.S. presidential election. Trump’s promises during his campaign, which include deregulation, tax cuts and expansion in infrastructure spending led investors to believe that Trump’s presidency will give a significant boost to the U.S. economy.
Oil Price Recovery
Impressive recovery in oil prices also played an important role in leading broader stock markets and of course small-cap stocks higher this year. Though the boom in shale oil production and rising output from OPEC led oil prices to hit multi year lows in the early part of the year, it recovered thereafter. A historic OPEC production cut agreement, together with help from non-OPEC producers and a reduction in investments helped oil prices to increase more than 100% from the February lows.
4 Top-Ranked Small-Cap Stocks to Buy Now
From the above sections, it can be easily concluded that there is enough scope for small cap stocks to continue their positive run next year, especially in an environment when the U.S. economy is indicated to expand further. Also, small-cap stocks are speculated to generate much higher returns than their large and mid-cap counterparts. Hence, it might be the ideal time to invest in some of the players in this space.However, picking winning stocks may be difficult.
This is where our VGM score comes in. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM score.
In order to pick the winners from the space, we have only considered those small-cap stocks that have a VGM Score of ‘A’ and a Zacks Rank #1 (Strong Buy).
CONE Midstream Partners LP (CNNX) owns, operates, develops and acquires natural gas gathering and other midstream energy assets. CONE Midstream Partners has surged 140.8% year-to-date, significantly outperforming the Zacks Oil/Gas Production Pipeline MLP sector, which has gained 13% over the same period.
Also, the company has an expected earnings growth of 33.1% for the current year in contrast to the industry’s negative growth rate of 9.9%.The forward price-to-earnings (P/E) ratio for the current financial year (F1) is 14.86, lower than the industry average of 18.32. Despite doubling this year, a favorable P/E ratio and strong growth prospect suggest that the stock still has scope to yield higher returns next year.
Eagle Bancorp Montana, Inc. (EBMT) operates as a holding company for American Federal Savings Bank that provides retail banking services in the south central portion of Montana. Eagle Bancorp Montana has jumped 69.5% year to date, significantly outperforming the Zacks Banks-Midwest sector, which has surged 34.1% over the same period.
Moreover, the company has an expected earnings growth of 91.8% for the current year, higher than the industry’s growth rate of 11.6%.The P/E ratio for the current financial year (F1) is 16.30, lower than the industry average of 19.80. These strong fundamentals indicate that the stock has the potential to extend its rally in the next year.
USD Partners LP (USDP) acquires, develops and operates energy-related rail terminals and other and complementary midstream infrastructure assets and businesses. USD Partners has soared 116.2% year-to-date, significantly outperforming the Zacks Transportation-Rail sector, which has gained 27.7% over the same period.
Additionally, the company has an expected earnings growth of 53.7% for the current year, compared to the industry’s growth rate of only 1.3%.The P/E ratio for the current financial year (F1) is 12.42, lower than the industry average of 19.65. These signal that the stock is poised to perform well in 2017 after more than doubling this year.
Dean Foods Company (DF) is one of the leading processors and distributors of fresh milk and other dairy products in the U.S. Dean Foods has gained 26.6% year-to-date, outperforming the Zacks Food-Dairy Products sector, which has increased 21.5% over the same period.
Moreover, the company has an expected earnings growth of 31.3% for the current year.The P/E ratio for the current financial year (F1) is 13.44, lower than the industry average of 18.83. Despite doubling this year, the stock still looks to be an undervalued choice, which in addition to its impressive growth prospects, makes it a potential buy for 2017.