Small-cap stocks could have a moment this year.
As optimism about the economy increases, the focus on Big Tech stocks as a safe haven during the pandemic is giving way to the so-called “reopening trade,” which includes small stocks with a market capitalization between $300 million and $2 billion. Just this year, through yesterday’s close, the Russell 2000 Index — made up of small-cap companies that stand to do better as the economy recovers — has gained roughly 10%, while the tech-heavy Nasdaq is up around 4%. For investors who are willing to put up with the risk of increased volatility that comes with smaller companies, here are seven of the best small-cap stocks to buy for 2021.
Citi Trends (ticker: CTRN)
Urban fashion retailer Citi Trends could benefit this year if additional economic stimulus sparks more consumer spending — and that’s not the only thing the company has going for it. The small-cap player has shaken up its management team, and Andrew St. Martin, portfolio manager at Anchor Capital Advisors in Boston, says he expects to see continuing margin improvement, the addition of new stores, the remodeling of existing units and investment in digital initiatives to help boost same-store sales. “We believe if Citi Trends can consistently execute on its growth strategy, its multiple will continue to re-rate and the valuation gap will close somewhat,” he says.
EVI Industries (EVI)
If St. Martin is right, this small-cap stock could really clean up in 2021. EVI sells, leases and services commercial laundry equipment for hospitals, government institutions, hotels, restaurants, cruise lines, nursing homes and vended laundry facilities. This year, it seems likely that the hospitality and cruise industries will regain lost ground as the rollout of vaccines continues. Over the longer term, St. Martin says EVI should be able to gain market share in its industry by buying and expanding leading local distributors. Margins should improve as the company integrates business lines, grows its service business and utilizes the greater bargaining power that comes with gaining size to get better deals with suppliers, he adds.
Winmark Corp. (WINA)
“Buy low, sell high” is an investing cliche that especially applies to Winmark, which franchises value-oriented retailers, such as Play It Again Sports, that buy used merchandise and sell it at a markup — but still cheaper than it would cost new. Although store closures and decreased customer traffic amid the pandemic have hurt its business, Winmark is a prime example of a business that should continue to perform better as the economy regains ground. “We expect revenue to improve as the (pandemic’s) impact wanes,” St. Martin says. Over the longer term, he likes Winmark’s franchise model that includes 10-year agreements and has a history of high renewal rates.
Fathom Holdings (FTHM)
Fathom, a real estate brokerage — which uses proprietary cloud-based software to provide a platform-as-a-service model for the residential real estate industry — is disrupting the real estate agent model, according to St. Martin. He thinks the company could end up with 10% operating margins in the long run. Additionally, he expects Fathom will offer its technology in a software-as-a-service format in 2022. That software business could end up bringing in $100 million in sales by 2024, by which time the company’s agent-based business could be generating $750 million, he adds. Today, Fathom has a market cap of roughly $500 million.
Construction Partners (ROAD)
Construction Partners could be one of the companies to benefit under President Joe Biden’s administration with a renewed focus on the country’s infrastructure. The civil infrastructure company specializes in building and maintaining roads in the southeastern U.S., and most of the company’s sales come from publicly funded contracts. St. Martin notes that the business is able to weather recessions well. Eventually, he says the company could be an acquisition target, with potential buyers like Granite Construction (GVA) and Summit Materials (SUM). In acquisitions, the buyer typically pays a premium on where the target’s shares are currently trading. “We like this one as investors look for infrastructure plays with the new administration,” he adds.
Mohawk Group (MWK)
This consumer products company uses machine learning and artificial intelligence to design, develop, market and sell products through online retail channels like those provided by Amazon.com (AMZN) and Walmart (WMT). According to St. Martin, the company, with its leading technology, could bring in $1 billion in revenue in two to three years. Mohawk’s 2019 net revenue came in at more than $114 million, and the company has said it expects net revenue for 2020 to be in the range of $175 million to $185 million. “E-commerce adoption continues to accelerate and we feel very well positioned to capitalize on this trend,” the company’s CEO said in comments accompanying its third-quarter results.
Perficient is a digital consultancy that generates most of its revenue from services that include developing, implementing, automating and extending business processes, technology infrastructure and software applications. Those services span multiple industries, but the company says it “has remained relatively diversified and does not believe that it has significant revenue concentration within any single industry, platform or solution.” St. Martin likes the company’s diverse mix of verticals, niche project sizing and relationships with multiple vendors that give it an advantage over smaller competitors. “Our longer-term thesis is based on a continued expectation of organic growth supplemented with bolt-on acquisitions,” he says.
Seven of the best small-cap stocks to buy this year:
— Citi Trends (CTRN)
— EVI Industries (EVI)
— Winmark Corp. (WINA)
— Fathom Holdings (FTHM)
— Construction Partners (ROAD)
— Mohawk Group (MWK)
— Perficient (PRFT)
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