Small Cap Stocks: How to Find the Russell 2000 All Stars

Alex Williams, Advisory Panelist, Investment U

Over the last 52 weeks, 2,725 stocks outperformed the S&P 500. And 2,356 of them – or 87% – were small caps. Trouble is, the small-cap universe, as a whole, can be tough to navigate. Over the same period, the Russell 2000 Index lagged the S&P 500.

The trick is to find the right small-cap stock – one that’s safe, yet growing its business quickly… and rewarding shareholders for taking an early position. Here’s one way to sift through the potent Russell 2000 Index and uncover a winner – using the stock screener of your choice:

Size: Isolate stocks with a market capitalization between $1 billion and $5 billion.

Growth: Screen your results again for companies growing earnings faster than 50% a year. According to TDAmeritrade’s stock screener, we’re already down to 31 companies.

Management Effectiveness: Now, to make sure we only consider well-managed companies, we’ll screen this batch for stocks that have a Return on Equity (ROE) greater than 10%, which shows us that management is using its equity wisely. This brings us to 15 candidates.

Valuation: From here, you can narrow the list even more by looking at key valuation metrics. Valuations vary depending on the industry, of course, but based on the current economic environment, we’ll look for companies with low debt levels – less than 25% of equity.

This leaves us with five small caps worth investigating:

1. Baidu (Nasdaq: BIDU)
2. Cliffs Natural Resources (NYSE: CLF)
3. NetEase, Inc (Nasdaq: NTES)
4. DreamWorks Animation SKG (NYSE: DWA)
5. Sohu.com, Inc (Nasdaq: SOHU)

This is just your first step, of course. Further research is required. Sohu.com, for example, is up more than 200% since 2008. But is it still worth buying? 

At least you’ll be one of the few investors who even know about it.

For more on profitable small-company investing, see the White Cap Index. It tracks the only fast-growing businesses worth buying on the Russell 2000.

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One Response to “Small Cap Stocks: How to Find the Russell 2000 All Stars”

1. Joanna Says:
   August 26th, 2009 at 7:11 am

   Great article and information.

   Reply

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