Barron’s recently pointed out that the S&P SmallCap 600 generated an annual return of 8.2% over the past decade, considerably less than the nearly 13% return for the S&P 500. Part of the problem is there aren’t as many profitable small-cap stocks available as there once were.
“Today, only about 60% of small-cap stocks in the Russell 2000 are profitable, down from 70% before the pandemic. It is one of the lowest levels since the 2008-2009 financial crisis,” Barron’s contributor Ian Salisbury wrote.
Between artificially low interest rates keeping suspect companies afloat to the attraction of staying private for longer, it’s harder to get enough quality cash-cow stocks.
However, a possible solution, says Salisbury, is to look through the holdings of quality-focused ETFs that look for companies with consistent profits and fortress-like balance sheets.
Here are three names from the Dimensional U.S. Small Cap ETF (NYSEARCA:DFAS). Each of the names has five years of consecutive profits and possesses little or no net debt.
Fabrinet (FN)
Fabrinet (NYSE:FN) provides advanced precision optical and electronic/mechanical manufacturing services for OEM (original equipment manufacturer) companies making complex and technical products for their customers.
The company finished Q3 2024 with almost $788 million in net cash on its balance sheet and three-year annualized growth rate for operating income of 30.0%. Its revenues grew by 17.2% annually over the past three years.
Fabrinet stock is up 32% year-to-date and 86% over the past year. Since the company’s IPO in June 2010 — it sold 8.5 million shares at $10 — its shares have appreciated by 2,400%.
Of the nine analysts who cover its stock, five rated it a buy, with a target price of $231.25, below where it’s currently trading.
In terms of revenues and operating profits in the latest quarter, Fabrinet’s revenues rose 10% to $731.5 million from a year earlier. Meanwhile, its operating income was $71.3 million, 15% higher than in 2023.
The company’s revenue in the quarter was $15 million higher than the analysts’ estimate for the quarter. On the bottom line, its GAAP earnings per share was $2.21, 10 cents higher than the consensus for the quarter.
With forecasted EPS of $2.05 at the midpoint of its guidance for the fourth quarter, it should earn $7.93 a share. Based on that estimate, it trades at 31x those earnings, which although high, is warranted for a company of its caliber.
UFP Industries (UFPI)
UFP Industries (NASDAQ:UFPI) is a Michigan-based company that provides products made from wood, wood and non-wood composites and other materials to three markets: retail (40% of sales), packaging (27%) and construction (33%).
Its retail business, which accounts for the greatest amount of sales, experienced a 17% decline in revenue in the first quarter of 2024 due to a combination of lower selling prices and unit sales. Orders from big-box customers fell by 9% while those from independent retailers fell 7%. The decline in orders was due to lower demand from their customers combined with conservative inventory levels.
The company finished Q1 2024 with $607 million in net cash on its balance sheet and three-year annualized growth rate for operating income of 22.0%. Its revenues grew by 11.9% annually over the past three years.
The company’s packaging and construction businesses had trailing 12-month adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) margins of 12.5% and 12.2%, respectively, through March 31. By comparison, its retail business, which is the largest by revenue, has an EBITDA margin of 7.6%, considerably lower.
Together, however, the three segments work together to ensure profits don’t disappear when prices fall and demand slows.
Comfort Systems USA (FIX)
Comfort Systems USA (NYSE:FIX) was one of three small-cap stocks I recently suggested could double in price over the next year. The company provides MEP (mechanical, electrical and plumbing) contracting services for new commercial buildings (55% of revenue) and those that are existing and in need of repairs and renovations (45%).
In addition to growing its sales through organic efforts, it also is an industry consolidator, using acquisitions to cost effectively buy revenue growth and talent. An acquisition is an effective way to fill gaps in your offerings.
“We believe that we can further increase our cash flow and operating income by continuing to opportunistically enter new markets or service lines through acquisition,” states pg. 5 of its 2023 10-K.
“We have dedicated a significant portion of our cash flow on an ongoing basis to seeking opportunities to acquire businesses that have strong assembled workforces, excellent historical safety performance, leading design and energy efficiency capabilities, attractive market positions, a record of consistent positive cash flow, and desirable market locations.”
While that’s quite the laundry list of requirements, if done effectively, this can accelerate a company’s growth trajectory.
As of March 31, the company had $199 million in net debt on its balance sheet and three-year annualized growth rate for operating income of 30.04%. Its revenues grew by 22.2% annually over the past three years.
Of the three, I like FIX the most.
— Will Ashworth
Legendary Stockpicker: "Buy this A.I. stock NOW" [sponsor]His award-winning system pinpointed NVDA and META before both stocks doubled. Now it's flashing "BUY" on this under-the-radar A.I. stock. MORE HERE...
Source: Investor Place