Is it Time to Be a Selective Buyer?

It hasn’t been a very happy New Year when it comes to stocks. Small caps are down 10% year-to-date and 19% from their June 2015 high. It’s almost as if the market had too much to drink as the ball dropped, then woke up in a strange place and wondered how the heck it got where it was. Its first reaction was to run and ask questions later.

Over the last three weeks, those questions have begun to flow. Confidence in the ability of the U.S. economy to remain strong in the face of so many global challenges is shaken. Unknowns related to the plunge in oil’s price lurk like dark shadows with devious intentions. And investor attention is increasingly turning back to central banks to see what actions, if any, will be taken to prop up economies and get the party started again. Europe, China and Japan are all in the crosshairs right now.

Small caps are back to where they were in October of 2013. They trade with a forward P/E below 16, a level last seen in early 2013 and October 2014. The market’s current action suggests an about-face in corporate growth, a shift from expansion to contraction—but it seems premature to come to that conclusion. If companies meet expectations and maintain guidance (at least) for the rest of the year, then this will be a tremendous buying opportunity.

That doesn’t mean everything will work, of course. And while I don’t necessarily think a rip-your-face-off rally will start this morning, the market’s valuation suggests there is more upside than downside right now. It seems rational to stick with high-quality names with earnings and revenue growth resulting from long-term growth trends.   

We’ve been through this before, most recently in mid-2011 when small caps fell by 30% from their peak (chart below). It doesn’t look too different from today’s market.

At that time, I wrote this note to subscribers:

“Corporate profits and liquidity remain very high, and in fact many companies continue to beat analyst expectations. So while governments may be struggling, many companies are doing quite well… So the markets, which represent the collective views of investors, are trying to figure out where the world's economies will go from here and how they'll deal with the reality that policy makers are running out of ammunition. Capital has to go somewhere, and despite volatility, stocks are the most compelling option…

For our purpose,s it's best not to get too caught up in the market's daily fluctuations. Naturally, this is easier said than done...but market corrections are a process, not a single point in time…so it is all the more important that we stick to our strategy during violent stock market gyrations and don’t try to get too cute. Remember, our strategy remains to buy attractive growth companies at reasonable valuations with significant exposure to global growth trends.”

With some variation on the details, the same holds true today. I don’t see enough to move to a bearish stance on the market, though certainly I reserve the right to alter my opinion. But right now, I plan to stick with my strategy: buy attractive small cap growth companies, at reasonable valuations, with significant exposure to global growth trends. We have a number in our current portfolio that are rated Buy, and I have a bunch more on my watch list that are candidates for the upcoming February issue.

On Tuesday, I hosted Cabot’s Lunch With The Analyst webinar, during which I talked about small caps in the context of time and the current market. I presented data supporting my opinion that it’s time to be a selective buyer right now. And I talked about stocks and trends. The replay is available here.

Tyler Laundon is Chief Analyst of Cabot Small-Cap Confidential. To read subscriber reviews of Cabot Small-Cap Confidential, click here.

This is an excerpt from Cabot Small-Cap Confidential, which features little-known stocks with big potential. It offers a limited number of subscribers the opportunity to discover overlooked, low-priced stocks that have the potential to skyrocket. This advisory is best suited to experienced investors who embrace volatility.

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