Buying The Small-Cap Breakout

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Includes: AEIS, BRKS, FORM, IWM, TNA
by: Zacks Investment Research

Stocks that are smaller in capitalization tend to be more volatile and riskier. For this reason, some investors shy away from smaller companies due to the risk of loss if markets were to sell off. However, these investors are missing out on one of the biggest ways to make money in the stock market. Smaller companies do offer risk, but they also offer massive reward when markets start trending higher.

Since Election Day, there has been a lot of sector rotation due to the surprise of Trump's victory. Banks, manufacturing and defense companies have soared higher in anticipation of Trump policies that will pad the bottom line.

While certain sectors have stuck out, small caps have shown their hand as well. The thinking is that a Trump presidency could move the needle for smaller companies. Lower taxes and less red tape could help small companies grow and become more profitable.

The market is signaling this with the iShares Russell 2000 ETF (NYSEARCA:IWM) up over 7% since the election last week. This kind of move doesn't happen often and investors should expect follow through into 2017.

Investors can gain exposure to small caps through IWM, but there are other ways to be more aggressive. A leveraged small cap ETF like Direxion Small Cap Bull 3X (NYSEARCA:TNA) seeks daily investment results, before fees and expenses, of 300% of the performance of the Russell 2000 Index. Investors can use TNA to get maximum upside, but need to be able to take the downside if the market were to turn.

Another way to gain exposure is through individual stocks. Below I list three top-ranked stocks that will benefit from a small-cap breakout.

Brooks Automation (NASDAQ:BRKS) is a Zacks Rank #1 (Strong Buy), delivers automation solutions to the global semiconductor and related industries. The Massachusetts-based company was founded in 1978.

Brooks has a $1 billion market cap with a forward P/E of 19. The stock sports Zacks Style Scores of "A" in both Growth and Momentum. For income investors, the company offers a dividend over 2.5%.

The company recently reported earnings in which it surprised to the upside by 46%. The beat sent the stock soaring over 15%. This move took the stock to all-time highs, and looking at estimates, it could see more upside.

Over the last 7 days, estimates have been revised higher for both the current and next year. For fiscal-year 2017, estimates have gone from $0.78 to $0.82, a 5% move. For 2018, estimates have gone from $0.95 to $0.98, or 3% higher.

Advanced Energy Industries (NASDAQ:AEIS) is a Zacks Rank #1 (Strong Buy) that designs, manufactures, sells, and supports power conversion products and solutions that transform power into various usable forms. The company was founded in 1981 in Colorado and has over 1300 employees.

AEIS has a market cap of $2 billion and a forward PE of 19. The stock has an expected 3-5 year growth rate of 12%.

Over the last month, the company has seen estimates revised aggressively higher. For fiscal-year 2016, estimates have moved 6% higher, from $2.51 to $2.67. For 2018, analysts have upped estimates 12% from $2.53 to $2.84.

FormFactor (NASDAQ:FORM) is a Zacks Rank #1 (Strong Buy) that designs, develops, manufactures, sells and supports precision, high performance advanced semiconductor wafer probe cards. The company was founded in 1993 and is headquartered in Livermore, California with almost 1000 employees.

The company has a $700 million market cap with a forward PE of 39. While the Style Scores aren't impressive, the company does have an expected 3-5 year growth rate of 12%.

In late October, the company reported earnings, beating on both the top and bottom line. The 26% surprise to the upside was the seventh straight EPS beat in eight quarters.

Estimates for 2017 have shot higher over the last month. Analysts now see FormFactor earning $0.68, up 3% from $0.66.

In Summary

Exposure to small caps is important for every long-term investor. Depending on risk tolerance, investors can take an aggressive approach through leveraged ETFs or stick a basic index ETF. For maximum exposure, individual stocks offer the greatest risk/reward, just be sure to stick with top-ranked stocks.

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