When it comes to small-capitalization stocks, the value sector performed best in the first quarter. Free cash flow was an important factor, says Bank of America strategist Jill Carey Hall.
“We say stick with it,” she wrote in a commentary. “Free-cash-flow-to-enterprise-value has also been one of the most alpha-generative factors over the long run in small caps. And value factors have led in Fed hiking cycles.” The term “alpha” means investment return.
Quality also was a strong positive for small-cap stocks in the first quarter.
“We would continue to stick with quality in small-caps, which tends to consistently lead in late-cycle [periods] and when volatility is elevated,” Hall said.
In addition, quality stocks are scarce on a historical basis, with 35% of Russell 2000 companies now unprofitable.
The best growth factor in the first quarter was operating margins, Hall said. “We would continue to focus on margins as well as more cyclical growth factors (estimate revisions, earnings surprise).”
That’s “where their scarcity is likely to be rewarded amid a decelerating growth/slowing revisions backdrop,” she said.
Bank of America created a list of small- and midcap stocks that are likely to beat analysts’ first-quarter-earnings estimates. Bank of America rates all of them as buy. The list includes:
· Alcoa (AA), the aluminum maker
· AutoNation (AN), the auto dealer chain
· Crane (CR), an industrial products company
· Harley-Davidson (HOG), the motorcycle maker
· Interactive Brokers (IBKR), a securities brokerage firm
· Knight-Swift Transportation (KNX), a trucking company
· Louisiana-Pacific (LPX), a building materials maker.
Morningstar's Take on Harley-Davidson, AutoNation
Morningstar analyst Jaime Katz assigns Harley a wide moat but with a negative trend. She puts fair value at $42, compared with a recent quote around $39.
On the plus side, “Covid-19 gave Harley the chance to reset its long-term strategy and focus efforts back on its core consumer, one which we believe holds the key to higher profit margins ahead,” Katz wrote in a February commentary.
“With the launch of ‘The Hardwire’ strategy, [Chief Executive] Jochen Zeitz is chasing the highest return-on-investment opportunities for Harley.”
On the minus side, “there are no switching costs to protect Harley's brand when consumers replace their bikes, and the premium price Harley commands relative to its peers has proven problematic during cyclical downturns and periods of competitive pricing,” she said.
As for AutoNation, Morningstar analyst David Whiston is bullish. He assigns it a narrow moat and puts fair value at $132, compared with a recent quote of around $101.
“We believe AutoNation's massive size and economy of scale advantages will allow the company to deliver operating margins often above 4%,” he wrote in a March commentary.
“And we see upside potential to profits as its AutoNation USA stand-alone used-vehicle stores roll out.
"There are 10 USA stores, and in April 2021 the firm announced plans to have over 130 by the end of 2026, with some in new U.S. markets.”
