The Russell 2000 Index has soared, but you might be better off looking elsewhere for quality small-cap stocks
By Philip van Doorn
A more selective small-cap index has consistently outperformed the Russell 2000
The Russell 2000 Index soared 12% in December, which might reflect investors' exuberance about the state of the U.S. economy - it appears the Federal Reserve has won its battle against inflation.
But if you are looking to broaden your exposure to the stock market beyond the large-cap S&P 500 SPX, buying shares of a fund that tracks the Russell 2000 Index RUT might not be the best way to do it. This is because the Russell 2000 isn't selective - it is made up of the smallest 2,000 companies by market capitalization in the Russell 3000 Index RUA, which itself is designed to capture about 98% of the U.S. public equity market.
A better choice might be the S&P Small Cap 600 Index SML because S&P Global requires companies to show four consecutive quarters of profitability to be initially included in the index, among other criteria.
Below is a screen of analysts' favorite stocks among the S&P Small Cap 600, along with another for the Russell 2000.
Watch for a "head fake"
Much of the small-cap buying in December might have resulted from covering of short positions by hedge-fund managers. This idea is backed by the timing of trading activity immediately following the Federal Open Market Committee's announcement on Dec. 13 that it wouldn't change its interest-rate policy, according to MacroTourist blogger Kevin Muir. The Fed's economic projections released the same day also indicate three cuts to the federal-funds rate in 2024.
Heading into the end of the year, a fund manager who had shorted small-caps, and then was surprised by the Fed's interest-rate projections, might have scrambled to buy stocks it had shorted to close-out the positions and hopefully lock in gains, or limit losses.
That buying activity and resulting pop in small-cap prices could set up a typical "head fake" for investors as the new year begins, according to Muir.
The long-term case for quality
Looking at data for companies' most recently reported fiscal quarters, 58% of the Russell 2000 reported positive earnings per share, according to data provided by FactSet. In other words, hundreds of these companies were losing money. These might include promising companies facing "binary events," such as make-or-break drug trials in the biotechnology industry.
In comparison, 78% of companies among the S&P Small Cap 600 were profitable, and 93% of the S&P 500 were in the black.
Here are long-term performance figures for exchange-traded funds that track all three indexes:
ETF Ticker 2023 3 years 5 years 10 years 15 years 20 years
iShares Russell 2000 ETF IWM 17% 7% 61% 99% 428% 365%
iShares Core S&P Small Cap ETF IJR 16% 25% 69% 129% 540% 515%
SPDR S&P 500 ETF Trust SPY 26% 34% 108% 210% 629% 527%
Source: FactSet
An approach tracking the S&P Small Cap 600 has outperformed the Russell 2000 for all periods, with margins widening as you go further back.
Brett Arends: You own the wrong small-cap fund. How to get into a better one.
Looking ahead for quality... or not
For the first screen, we began with the S&P Small Cap 600 and narrowed the list to 385 companies covered by at least five analysts polled by FactSet. Then we cut the list to 92 companies with "buy" or equivalent ratings among at least 75% of the covering analysts.
Here are the 20 remaining stocks among the S&P Small Cap 600 with the highest 12-month upside potential indicated by analysts' consensus price targets:
Company Ticker Share "buy" ratings Dec. 29 price Consensus price target Implied 12-month upside potential
Vir Biotechnology Inc. VIR 88% $10.06 $32.00 218%
Arcus Biosciences Inc. RCUS 82% $19.10 $41.00 115%
Xencor Inc. XNCR 92% $21.23 $39.83 88%
Dynavax Technologies Corp. DVAX 100% $13.98 $24.80 77%
ModivCare Inc. MODV 100% $43.99 $75.50 72%
Xperi Inc XPER 80% $11.02 $18.20 65%
Thryv Holdings Inc. THRY 100% $20.35 $32.75 61%
Ligand Pharmaceuticals Inc. LGND 100% $71.42 $114.80 61%
Green Plains Inc. GPRE 80% $25.22 $40.30 60%
Patterson-UTI Energy Inc. PTEN 75% $10.80 $17.00 57%
Ironwood Pharmaceuticals Inc. Class A IRWD 83% $11.44 $17.83 56%
Catalyst Pharmaceuticals Inc. CPRX 100% $16.81 $26.20 56%
Payoneer Global Inc. PAYO 100% $5.21 $8.00 54%
Helix Energy Solutions Group Inc. HLX 83% $10.28 $15.00 46%
Arlo Technologies Inc. ARLO 100% $9.52 $13.80 45%
Pacira Biosciences Inc. PCRX 100% $33.74 $48.40 43%
Privia Health Group Inc. PRVA 100% $23.03 $32.53 41%
Semtech Corp. SMTC 92% $21.91 $30.90 41%
Talos Energy Inc. TALO 78% $14.23 $20.00 41%
Digi International Inc. DGII 100% $26.00 $36.14 39%
Source: FactSet
Any stock screen should only be considered a starting point. You should do your own research to form your own opinion before making any investment. one way to begin is by clicking on the tickers for more about each company.
Click here for Tomi Kilgore's detailed guide to the wealth of information available for free on the MarketWatch quote page.
Moving on to the Russell 2000, when we narrowed this group to stocks covered by at least five analysts polled by FactSet, we were left with 936 companies. Among these, 355 have "buy" or equivalent ratings among at least 75% of the covering analysts.
Among those 355 stocks in the Russell 2000, these 20 have the highest implied upside over the next year, based on consensus price targets:
Company Ticker Share "buy" ratings Dec. 29 price Consensus price target Implied 12-month upside potential Karyopharm Therapeutics Inc. KPTI 75% $0.87 $6.00 594% Rallybio Corp. RLYB 100% $2.39 $16.50 590% Vor Biopharma Inc. VOR 100% $2.25 $15.44 586% Tenaya Therapeutics Inc. TNYA 100% $3.24 $19.14 491% Compass Therapeutics Inc. CMPX 86% $1.56 $9.17 488% Vigil Neuroscience Inc. VIGL 88% $3.38 $18.75 455% Trevi Therapeutics Inc. TRVI 100% $1.34 $7.33 447% Inozyme Pharma Inc. INZY 100% $4.26 $21.00 393% Gritstone bio Inc. GRTS 100% $2.04 $10.00 390% Actinium Pharmaceuticals Inc. ATNM 83% $5.08 $23.36 360% Lineage Cell Therapeutics Inc. LCTX 86% $1.09 $4.83 343% Century Therapeutics Inc. IPSC 86% $3.32 $14.67 342% Acrivon Therapeutics Inc. ACRV 100% $4.92 $21.13 329% Avidity Biosciences Inc. RNA 100% $9.05 $37.50 314% Longboard Pharmaceuticals Inc. LBPH 100% $6.03 $24.17 301%
(MORE TO FOLLOW) Dow Jones Newswires
01-06-24 0558ET
Copyright (c) 2024 Dow Jones & Company, Inc.-
What History Tells Us About the Fed’s Next Move
-
What’s Happening In the Markets This Week
-
Alphabet’s New Dividend: What Investors Need to Know
-
Going Into Earnings, Is Palantir Stock a Buy, a Sell, or Fairly Valued?
-
Going Into Earnings, Is Eli Lilly Stock a Buy, a Sell, or Fairly Valued?
-
What’s the Difference Between the CPI and PCE Indexes?
-
5 Stocks to Buy That We Still Like After They’ve Run Up
-
Markets Brief: Stocks Are Starting to Look Cheap Again
-
AbbVie Earnings: Next-Generation Immunology Drugs Help Offset Humira Biosimilar Pressure
-
Exxon Earnings: Ignore Earnings Shortfall as Long-Term Growth and Improvement on Track
-
American Airlines Earnings: We See Costs Overshadowing Market Share This Year
-
Snap Earnings: Advertising Growth and Snapchat+ Drive Monetization
-
STMicro Earnings: We Still See an Attractive Margin of Safety Despite a Poor First-Half Forecast
-
Alphabet Shares Surge on Strong Earnings, Dividend Surprise
-
Microsoft Earnings: Firm Beats Forecasts on Strong AI and Cloud Demand
-
PG&E Earnings: Near-Term Regulatory Certainty Supports Industry-Leading Earnings Growth