The Russell 2000 (^RUT) is packed with potential breakout stocks, thanks to its focus on smaller companies with high growth potential. However, smaller size also means these businesses often lack the resilience and financial flexibility of large-cap firms, making careful selection crucial.
Navigating this part of the market can be tricky, which is why we built StockStory to help you separate the winners from the laggards. Keeping that in mind, here are three Russell 2000 stocks that don’t make the cut and some better choices instead.
Q2 Holdings (QTWO)
Market Cap: $5.61 billion
Founded in 2004 by Hank Seale, Q2 (NYSE: QTWO) offers software-as-a-service that enables small banks to provide online banking and consumer lending services to their clients.
Why Does QTWO Worry Us?
- Revenue increased by 11.7% annually over the last three years, acceptable on an absolute basis but tepid for a software company enjoying secular tailwinds
- Gross margin of 51.8% is way below its competitors, leaving less money to invest in areas like marketing and R&D
- Capital intensity will likely increase as its free cash flow margin is anticipated to drop by 2.4 percentage points over the next year
Q2 Holdings’s stock price of $89.98 implies a valuation ratio of 7.3x forward price-to-sales. To fully understand why you should be careful with QTWO, check out our full research report (it’s free).
Simply Good Foods (SMPL)
Market Cap: $3.37 billion
Best known for its Atkins brand that was inspired by the popular diet of the same name, Simply Good Foods (NASDAQ: SMPL) is a packaged food company whose offerings help customers achieve their healthy eating or weight loss goals.
Why Are We Cautious About SMPL?
- Subscale operations are evident in its revenue base of $1.41 billion, meaning it has fewer distribution channels than its larger rivals
- 3.1 percentage point decline in its free cash flow margin over the last year reflects the company’s increased investments to defend its market position
- Below-average returns on capital indicate management struggled to find compelling investment opportunities
At $33.18 per share, Simply Good Foods trades at 16.7x forward P/E. Read our free research report to see why you should think twice about including SMPL in your portfolio.
GMS (GMS)
Market Cap: $3.00 billion
Founded in 1971, GMS (NYSE: GMS) distributes specialty building materials including wallboard, ceilings, and insulation products, to the construction industry.
Why Does GMS Fall Short?
- Core business is underperforming as its organic revenue has disappointed over the past two years, suggesting it might need acquisitions to stimulate growth
- Projected sales decline of 3.7% for the next 12 months points to a tough demand environment ahead
- Earnings per share have contracted by 13.3% annually over the last two years, a headwind for returns as stock prices often echo long-term EPS performance
GMS is trading at $78.06 per share, or 10x forward P/E. Check out our free in-depth research report to learn more about why GMS doesn’t pass our bar.
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