High-Growth Small-Cap Stocks Eye Recovery After Prolonged Exclusion from Market Rally

Small-cap stocks eye recovery after market exclusion

Small-cap stocks with high growth potential have faced exclusion from the market rally for an extended period, largely overshadowed by their larger counterparts. However, exercising careful selectivity when investing in these small-cap stocks is anticipated to yield significant dividends in the long run, as their growth potential remains robust and poised for future gains.

iShares Russell 2000 Growth ETF: An Overview

The iShares Russell 2000 Growth ETF focuses on companies averaging $6 billion in market capitalization. It aims to exceed profit growth of the S&P 500, Nasdaq Composite, and other small-cap indexes. Despite its goals, the ETF has dropped 22% from its early 2021 peak, contrasting with Nasdaq’s recent highs.

The iShares Russell 2000 Growth ETF’s market cap focus and growth goals underwhelmed amid recent declines, WSJ Subscription Offers said.

Impact of Elevated Interest Rates

These small-cap stocks face a significant challenge due to high interest rates, worsened by several Federal Reserve rate hikes recently. Many firms in this ETF operate at a loss and heavily depend on external funding to grow until they become profitable. Rising interest rates raise financing costs, reducing the appeal of future cash flows from expanding businesses and straining some companies financially.

Uncertain Prospects Despite Potential Rate Cuts

Although there are signs that the Federal Reserve may cut rates, these stocks have yet to gain significant traction. The certainty of rate reductions remains doubtful due to persistent inflation above the Fed’s target. Moreover, investor focus and capital have been absorbed by Big Tech’s advancements in artificial intelligence.

Signs of Recovery in Small-Cap Growth Segment

Encouragingly, the small-cap stocks growth segment has started to show signs of recovery. The ETF has rebounded by over 1% from its multi-month low on June 14, outperforming the slight dip in the Nasdaq Composite during the same period.

Bank of Japan to reduce bonds, hinting at tightening.

Bank of Japan to reduce bonds, hinting at tightening.

In a pivotal move reflective of its economic outlook, the Bank of Japan (BOJ) announced today its decision to reduce purchases…

Attractive Valuations Drawing Fresh Capital

Reduced valuations in the small-cap sector are driving new investments into overlooked growth stocks, fueling the resurgence. The growth ETF’s current trading level is just under 33 times forward earnings estimates for the next 12 months, halving its 2021 peak. This marks a mere 16% premium over the Nasdaq’s 28.2 times, contrasting sharply with the average 50% premium over the past five years, per FactSet data.

Identifying Promising Small-Cap Growth Stocks

The critical task at hand is to pinpoint the most promising growth opportunities among Small-cap stocks. While there remains lingering skepticism regarding the timing of aggressive rate cuts, there exist selective opportunities that warrant exploration.

Trivariate Research’s Top Picks

Trivariate Research identifies small-cap growth firms with improved profit margins and free cash flow. They also look for reduced volatility compared to historical levels. This strategy aims to pinpoint stocks with less downside risk in market downturns. These companies are chosen for their strong fundamentals and potential for upside growth.

CommVault Systems: A Standout Performer

CommVault Systems, valued at $5.5 billion, provides cybersecurity software, especially against ransomware threats. In 2024, it generated $895 million in revenue, mainly from subscriptions, with a robust 21% operating margin. Analysts anticipate steady annual sales growth in the low double digits through 2026, supporting 15% annual bottom-line growth.

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