Most stocks haven’t been able to sustain their fast start to 2023, but these small and mid caps are outperforming and primed to keep growing.
Investors’ hopes for a fast rebound in the stock market in 2023 have fizzled since the New Year’s rally, with the S&P 500 falling 2% since a 6.2% January bounce, but small and mid cap stocks have sustained their advantage in the first quarter of the year, and many are still trading at attractive valuations.
The Russell 2000 index is up 6.7% this year, beating the S&P 500’s 3.8% gain, and one stock fueling that outperformance so far is Denny’s, posting a 25% gain this year after three years of underperforming. The franchised diner chain known for its Grand Slam breakfasts complete with pancakes, eggs, bacon and sausage generated $456 million in revenue last year, 15% higher than 2021 though below its typical pre-Covid performance. Its stock is still down 50% from its summer 2019 peak and trades at just 9.8 times earnings, half the 19.6 average trailing P/E for the S&P 500.
Denny’s is not an anomaly. Investors who put their money where their mouth is in small caps are feasting this year.
Denny’s is not an anomaly. Investors who put their money where their mouth is in small caps are feasting this year. Shake Shack is up 40% following years of rapid revenue growth, though it is unprofitable, and stocks including Cracker Barrel Old Country Store, Jack in the Box and Wingstop are all up double digits.
Restaurants are continuing to churn out takeout orders after fortifying their systems during the pandemic and are thriving with in-person dining back near normal levels as well. Truist analyst Jake Bartlett says more than two-thirds of Denny’s locations are back to 24-hour service now, a figure that was at about 95% before the pandemic but dropped to less than half as of a year ago, and new ovens in their kitchens will help bolster their dinner options.
“Most categories of restaurants have recovered to higher than pre-Covid sales levels,” says Bartlett, who has a buy rating on Denny’s. “The family dining category has still been the most lagging in the recovery, so there’s still a lot of room for the family diners to continue that.”
Denny’s is one of 26 small- and mid-cap stocks Forbes identified using data from YCharts that have gained at least 20% this year, outperforming the market, while maintaining cheap price to earnings ratios at less than 15, with expected revenue growth for this fiscal year and a low debt-to-equity ratio. These strong small stocks have already rewarded investors navigating a shaky market and still appear to be bargains.
The list includes blue jeans maker Kontoor Brands, the parent company of brands like Wrangler and Lee, Western apparel retailer Boot Barn and oil and gas driller Permian Resources. Brunswick Corp., which has gained 22% this year and has a P/E ratio less than 10, manufactures boats and boat engines through well-known brands like Mercury and Boston Whaler. The Mettawa, Illinois-based company was founded in 1845 and began by making horse carriages and pool tables. It acquired Mercury Marine in 1961 and has since pivoted entirely to the water, and acquired marine electronics and sensors firm Navico for $1.05 billion in 2021. Brunswick recorded a record $6.8 billion in sales last year.
The average factory-built home costs $70,000 to $200,000, while median existing home prices are above $350,000.
Housing is another sector that crops up several times on our list, despite rising mortgage rates and recession fears hampering demand. Skyline Champion, a leader in the factory-built home industry, has gained 34% this year, and competitor Cavco Industries is up 28%. These two companies manufacture modular homes and RVs and transport them to sites for customers, so unlike traditional homebuilders, land acquisitions are unnecessary. Both have little to no debt and have gained market share as sales at each have more than doubled in the last two years.
“Traditionally, the target consumer for this type of housing would have been a lower income consumer,” says Greg Palm, senior research analyst at Craig Hallum Capital Group. “What you’re seeing now is a much higher-income consumer that’s getting priced out of traditional site-built housing.”
Skyline Champion sold 26,000 homes in 2022 and Cavco sold nearly 20,000, compared to at least 65,000 for America’s largest traditional home-builders D.R. Horton and Lennar. Those industry leaders have market capitalizations around $30 billion, compared with $3.9 billion for Skyline Champion and $2.5 billion for Cavco, but analysts expect factory-built models to continue gaining traction thanks to their affordability. Jay McCanless, senior vice president at Wedbush, says the average factory-built home costs $70,000 to $200,000, depending on how many sections they include, while median existing home prices are above $350,000, though that figure typically includes the land as well.
Mortgage lender UWM Holdings is surprisingly one of the top performing stocks in the screen, with a 40% gain year to date, though it remains 65% below its peak at the end of 2020 after taking a beating for two years. Founded by billionaire Mat Ishbia, who finalized his acquisition of a majority stake in the NBA’s Phoenix Suns in February at a $4 billion valuation, UWM’s revenue plunged 41% in 2021 to $2.1 billion as originations cratered. The company and its larger mortgage competitor Rocket Companies, cofounded by billionaire Cleveland Cavaliers owner Dan GIlbert, have both handily beaten the S&P 500 and Russell 2000 year-to-date..
“I think part of this is a bit of a relief rally. People realize that from a valuation perspective, these names have gotten way too cheap, even in a lower volume purchase environment,” says McCanless. “There may be the belief that the big are only going to get bigger, especially in a slower market.”
See below, for the full list of 26 small-cap bargains off to a strong start in 2023:
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Source: https://www.forbes.com/sites/hanktucker/2023/03/09/from-power-boats-to-grand-slam-breakfasts-27-small-cap-bargains-defying-a-difficult-market/