3 Small Caps For Growth

Includes: BKE, RS, SOUP
by: Robert Taylor

It's well known that stocks as an asset class have delivered strong returns over the long run. However, some corners of the stock market have performed better than others. In particular, small-cap stocks - those with a market capitalization of between $300 million and $2 billion - have outperformed large-cap stocks over time.

According to research from investment management firm Royce & Associates, over the last 50 years, small-cap stocks have delivered average annual returns of 11.3% compared to 9.1% for the larger S&P 500. The magnitude of that number might be better expressed in numbers.

Let's say someone invested $10,000 during that time. With the S&P, he or she would have wound up with $23.4 million. That's a sizeable sum, however, with small caps, it would have amassed a remarkable $100.4 million. Small caps allow investors to explore certain markets without risking an extensive amount of money.

With this in mind, I've listed a few of my top picks in sectors that look to be picking up as the economy eases- namely, retail, food and materials.

In retail, I like The Buckle (NYSE:BKE). The Buckle is a leading retailer of casual apparel, footwear and accessories for young men and women. Shares of the apparel retailer hit an all-time high above $51 a share late last year, and its latest financials (Q3 FY2013) represented a solid beat on the top and bottom lines.

Growth primarily came from its men's denim brand. The sell-side expects slowing EPS growth over the next five years, averaging about 8.5% annually, but Buckle's stock price still trades at a cheap 13.4 times forward earnings. Moreover, a dividend yield of 1.7% gives an additional cushion, so to speak.

Another benefit of this pick comes from other research as the specialty retail market sector is looking promising. Analysts combine this with an estimated 11.75% EPS growth from the company over the next few years.

The Buckle's expansion across the US is yet another reason to consider the company. While it has yet to reach out overseas, it has opened 49 franchised locations last year. These locations don't require the capital investment of a company owned store, and should provide a boost to the bottom line.

In food, I like The Original Soup Man (OTCQB:SOUP). Soupman has seen some impressive growth this year. In addition to getting its delicious soup on the shelves of Wegmans and Whole Foods, it has finalized a deal with Robert Azinian and CCA Foods, Inc., to lead the expansion of its Al's Famous New York Delicatessen & Restaurant model in Casinos throughout the US and Canada. The next two locations are opening in the Mohegan Resorts Casino in Atlantic City and the Mohegan Sun at Pocono Downs in PA in 2013.

With a market cap of about 17.3M, just this week the stock is up 17%. Soupman is riding the wave of its current rating as Zagat's #1 "best-tasting soup in the world." It's quick growth, momentum in advertising, as well as positive stock performance year to date, I see this as a great opportunity for investors to look into.

Last but certainly not least, I submit Reliance Steel & Aluminum (NYSE: RS). Reliance has provided investors with a return (16.2%) nearly three times that of the metal fabrication industry's average over the past 12 months, and has also performed quite impressively over the shorter term. The company has beaten the sell-side's earnings consensus reaching $2.03 billion. Net income was reported as $83.7 million, up 4.1% from $80.4 million in the fourth quarter of 2012.

Other financials include cash flow from operations was $72.2 million and net debt-to-total capital was 22.4% at March 31, 2013. Finally, investors will enjoy a quarterly cash dividend of $0.30 per share which was announced two weeks ago payable on June 21.

Of course, one must mention risks involved in small-cap stock investing. For example, smaller companies have less financial resources and limited access to capital compared to larger companies which may make it more difficult to obtain financing to pursue new growth. Moreover, less information is publicly available about these companies, and what is known is often by the companies' own press statements.

Taking risks into account, small and mid-cap stocks comprise about 20 percent to 25 percent of total stock market capitalization, so a market-neutral exposure requires that a similar percentage of your personal equity portfolio should be allocated to small and mid-caps. Simply put, if investors want outsized returns, they must invest in small-cap stocks, and start with these impressive performers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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