Based on historical trends, small- and medium-cap stocks have fared better than large- and mega-cap stocks. The Russel 2000 index, which marks the movement of the small-cap stocks, grew by an incredible 85% while the S&P Index showed an increase of only 7% over the last eight years. There are some very attractive investment opportunities available in the small-cap segment.
In my opinion, three stocks, namely 8x8 Inc (EGHT), American Railcar Industries (ARII) and Dorman Products (DORM), are extremely attractive due to the growth prospects, and these stocks are set to grow in the near future.
8x8 operates in the communication equipment industry. The U.S.-based company provides telecommunication services and technology via IP and video applications to small and medium businesses. The corporation faces competition from Telecom giants such as AT&T (T), CenturyLink (CTL) and Verizon (VZ) along with some small pure IP services and equipment providers; however, its competitive pricing provides 8x8 with a strategic advantage.
The company reports its consolidated revenues in two broad segments, namely services and products. The previous three years have proved extremely encouraging for the company as the revenue for 8x8 has grown at an average of 12.16%.
8X8 plans to expand its sales via an indirect sales channel authenticated by a 20% increase in marketing and sales expenditure year-over-year. Research and development expenditure too increased by 39% amounting to $6.7 million in the last year. It shows that the company is making substantial efforts to capture the growth opportunity in the market.
The biggest threat for the company is increasing competition in the market - however, the strategic advantage offered by its pricing structure and strong patent portfolio will ensure that the impressive growth for 8x8 continues in the future. The P/E ratio of the stock stands at 7.2.
One of the biggest factors for future growth is the cost-cutting measures taken by the small and medium businesses. The businesses are moving towards low-cost telecom options, and IP services are a cheaper option compared with other telecom services. As a result, there are substantial growth opportunities in the market.
American Railcar Industries
American Railcar is a vertically integrated designer and manufacturer of hopper and tank railcars. It provides its investors with a diverse operational portfolio in both the manufacturing and services segments. The company has expanded its operations via joint ventures, namely Ohio Castings, Axis and its recent collaboration with Indian Railways.
The year 2011 can be characterized as a year of recovery for the railroad industry and the corporation itself. The revenue growth for the last three years stands at 18.9%. Growth in net income follows a similar trend with the figure touching 60% beating the industry average by a substantial margin. The EPS for 2012 stands at extremely impressive $3, compared with $0.2 in 2011.
The company has expanded its operations within United States along with international ventures. The aforementioned acquisitions provide the company with cost-reduction synergies, explaining the high net operating margin of 18%. The management plans to expand its operations in the international arena, mainly Russia and the Middle East. The expansion plans are backed by a massive increase of 472% in capital expenditure year-over-year. At the moment, the dividend yield is 2.79%, and analysts expect it to increase in the future as the growth prospects materialize into higher earnings.
Despite high growth in revenues and net income, the risks associated with this small-cap stock cannot be denied. Earnings in the railcar industry are subject to cyclical fluctuations, adversely impacted by an economic slowdown. The narrow supplier and customer base exposes the company to serious operational risks. Furthermore, the unsecured debt issued by the company limits its financial flexibility.
The P/E ratio and the forward P/E ratio stand at 11 and 8.2, respectively. Furthermore, the P/B and P/S ratio stand at 2 and 1.1, respectively.
Dorman Products was incorporated in Pennsylvania, in October 1978, and it is a supplier of automotive replacement parts and fasteners and service line products. The company markets its products through a sophisticated distribution channel via national, regional and local warehouses.
The enterprise earns about 43% from its distribution channels, 42% from the retailers segment and around 15% from international operations. Average growth in revenue for the past three years stands at 14.8%, and growth in net income stands at 38.9%.
The company commits to its policy of growth from within and has a history of not paying any dividends - however, a special cash dividend of $1.50 per share was paid at the end of the last year, which resulted in total cash outlay of $55 million. Capital expenditure for 2012 remained constant at $18 million while free cash flows increased by $11 million due to an improvement in operating cash flows.
This small-cap stock, however, is subject to certain risks that should be taken into account. The operations of the company are backed by a narrow customer base. Furthermore, the policy to give out loans to its customers exposes the company to additional credit risks. Lastly, the company operates in a consumer cyclical sector therefore making the earnings of the company more vulnerable to adverse market conditions.
The forward P/E ratio is projected to fall to 17 from a current P/E ratio of 22.8 as the stock price stabilizes. The P/B and P/S ratio are above the industry average at 4.6 and 2.7, respectively.
All of the above mentioned stocks have shown incredible performance over the past 12 months -- 8x8 is up about 90%, ARII about 62% and DORM is up about 82%. These companies are operating in growing industries and have solid market positions. As a result, I believe these companies will continue to grow at an impressive rate and result in substantial gains for investors.