July was a banner month for small-cap stocks, with the Russell 2000 index soaring 10%.
It also represented a month of change within the small-cap category.
“This year's top styles, value and quality, both underperformed” in the small-cap universe during July, Bank of America strategists wrote in a commentary.
But, “both late [economic] cycles and downturns support sticking with quality within small caps, as well as value over growth and cash return factors,” they said.
“Dividend yield and share repurchases also underperformed in July, but have been among the best-performing factors within the Russell 2000 year to date.”
Meanwhile, “stocks with both high and expanding operating [profit] margins outperformed the equal-weighted Russell 2000 index last month,” the strategists said.
“We think these factors will likely continue to be rewarded, especially as inflation has remained higher for longer.” Consumer prices soared 8.5% in the 12 months through July.
Free Cash Flow
“Free cash flow also tends to be even more rewarded in late-cycle markets,” the strategists said. “Free cash flow-to-enterprises value and and free cash flow-to-price have been two of the top-performing long factors within small caps year to date.”
In addition, “estimate revisions has been one of the best performing growth factors within the Russell 2000 year to date,” the strategists said.
“As estimate revision ratios have continued to trend downward, we expect a continued reward for positive earnings-per-share revisions as they grow scarcer.”
With all this in mind BofA strategists formed a list of Russell 2000 stocks, “which rank highly on two attributes … which we expect to continue to be rewarded against the backdrop of sticky inflation and estimate cuts: operating margin expansion and positive EPS estimate revisions,” they said.
The list includes stocks with positive three-month earnings revisions and margin expansion over the last 12 months. And BofA analysts rate the stocks buy or neutral.
The List
Here are 10 of the 12 companies on the list rated buy.
· Texas Roadhouse (TXRH) a restaurant chain,
· Clarus (CLAR), an outdoor equipment maker,
· ShockWave Medical (SWAV), a cardiovascular medical device company,
· Patterson (PDCO), which provides veterinary and dental products,
· ASGN (ASGN), which provides information technology services,
· First Advantage (FA) , which provides background-check services,
· Macom Technology Solutions (MTSI), which makes radio and microwave semiconductor devices,
· KnowBe4 (KNBE), a platform for security awareness training,
· E2open (ETWO) , which provides supply chain software,
· Greif (GEFB) , which makes industrial packaging products.
