The Case for Small Cap Value Stocks:

  • The chart below shows that Small Cap Value is as cheap vs. Large Cap Value as any time in history
  • We have been drawing peoples’ attention to the growing opportunity in charts and white papers on quality spreads in mid cap and small cap companies
  • As demonstrated in nearly a dozen of our quick takes and white papers, the euphoric mania for growth stocks has left pockets of fantastic opportunities for disciplined active managers willing to buy quality at reasonable prices

Price to Sales Spreads R1V vs R2V

Since the trough of the Covid crash on March 23, 2020, Small Cap Value stocks have risen 128.44% vs Large Cap Value stocks rising “only” 93.21%. This has led some to worry that Small Cap Value has run too far. The KCR team notes that since 2017 however, Large Cap Value has beaten Small Cap Value by nearly 2% annually (+59.49% vs. +46.21%).

The table below shows the basic fundamentals of the following three groups:

  1. The first row is the Russell 1000 Value Index
  2. The second row is the Russell 2000 Value Index
  3. The third row shows our top 10 ranked Small & Midcap stocks in the Russell 2000 Value Index

R1V R2V and Kailash Top 10 Fundamental Table

KCR thinks the appeal of moving down the groups is reasonably obvious. The major complaint we could see coming from a cursory observation of the indexes are the elevated PE ratios and the lower ROAs of the small caps. We do not profess to be experts in Large Value vs. Small Value (yet!) but a cursory examination of the two benchmarks is informative.

The R2V has a 12% weighting in REITs, nearly triple that of the R1V, and the sector’s earnings are still reeling from the pandemic. Needless to say, a vast array of stocks that have negative PE ratios in the R2V REIT sector does not flatter the overall index valuation[1]. Looking at FCF/EV however we get a better sense of the opportunity in the R2V. Overall, many of the loss making firms in the R2V have not actually translated to negative cash flows.

We ask our readers to focus on the last row in the exhibit: our top 10 ranked names in the Russell 2000 Value index.

Suffice it to say: the opportunities strike us as substantial. With an 8.6% FCF yield and valued at only 0.4x sales, our top ranked firms appear priced for disaster. Many of our top ranked names have only one or two analysts, are involved in logistics, transportation, housing and automotive sectors – and some have global brand recognition!

In a world where the Russell 1000 Growth Index has a 44% weighting in tech names trading at stratospheric valuations, we think there might be much to endorse these small businesses that engage in the prosaic. The KCR research team has no idea if Square can grow into its $120 billion market cap and 730x PE ratio.

We do however think some of our top ranked small cap value names will be shipping goods and selling tires for many years to come. For an example of a possibly mispriced small cap stock please see our free write-up on MHK’s stock price – this is a company that is a great example of how we think about the opportunities that exist today in a quantamental framework.

Login or subscribe below to see the list of potential stocks to buy after some diligent fundamental research. You can also click here for our Small Cap ranking tool. For growth investors, we continue to advocate for the lost are of “growth at a reasonable price” as we believe the opportunities there are the best we have seen in our lifetimes!

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

  1. Click the following to read more about booming stock

[1] Our calculation of index level PE ratios uses the average earnings to price ratios of every firm and providing a multiple of the value-weighted reciprocal.  Firms with negative earnings cause the PE ratio of the Russell 2000 Value Index to appear much higher (87.2x) due to these negative PE firms.  If you have any questions please reach out to info@nullkailashconcepts.com

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

July 30, 2021 |

July 30, 2021

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