When the economy starts to recover, small companies will benefit. Here are some stocks to watch.
IN THE RECENT market downturn, small stocks have been hit particularly hard. During the 12 months ending in March, the average small-cap fund lost 11.6%, lagging large-cap funds by more than nine percentage points. This is not surprising. In bear markets investors avoid small stocks, moving to big blue chips.
But you should not steer away from small stocks now. The markets will rebound. And during recoveries, small stocks tend to lead the comeback as investors gain confidence and seek businesses with growth potential.
Plus, there is reason to think that we are near the end of the downturn in small stocks. Many bear markets last only about a year, and the current decline in small stocks has been going on nearly twice that long.
Even if the overall bear market lasts longer than average, this may be the time to shop for small stocks. Many shares sell at big discounts to their historical price levels. In any case, most investors should hold at least some small stocks because they can help to diversify a portfolio; small stocks sometimes rise while big stocks languish.
To benefit from the potential revival of small stocks—while taking limited risk—stick with solid companies that have strong balance sheets and little debt, says Michael Petroff, portfolio manager of Heartland Value Plus Fund. “This is not a time to speculate on shaky start-ups that could go under,” says Petroff.
Companies that pay larger dividends tend to have steady cash flows. And if the bear market persists, dividend payers provide income while investors wait for the shares to revive.
When the economy recovers, Werner Enterprises should come roaring back, says Petroff. Werner operates trucks, hauling supplies for retailers and grocery chains. That business will recover quickly when the economy improves. The company, which pays a dividend of 1.1%, has the financial strength to survive any market condition.
A stock that may be helped by a recession is Asset Acceptance Capital. After purchasing defaulted accounts from healthcare providers and credit card companies, Asset Acceptance attempts to collect. “This company is benefitting from all the problems that consumers are having,” says Petroff.
Investors who prefer funds should consider Pennsylvania Mutual. It's a broad basket of undervalued small stocks.
Portfolio manager Charles Royce buys solid companies that have suffered temporary problems. During the past five years, Pennsylvania Mutual has returned 17.1% annually, outdoing 80% of its small-cap peers and beating the Standard & Poor's 500-stock index by more than five percentage points annually.
Another low-risk choice is Managers Special Equity. The fund's assets are divided among six different managers. While some of the fund's portfolio managers look for undervalued shares, others favor more expensive stocks with fast-growing earnings. The diversified portfolio can thrive during a variety of market conditions. By holding this steady fund, investors can be prepared for the day when small stocks again outshine the rest of the market.