Small-cap stocks can be incredibly lucrative investments because their lack of analyst coverage leads to frequent mispricings. However, these businesses (and their stock prices) often stay small because their subscale operations make it harder to expand their competitive moats.
These trade-offs can cause headaches for even the most seasoned professionals, which is why we started StockStory - to help you separate the good companies from the bad. Keeping that in mind, here are three small-cap stocks to avoid and some other investments you should consider instead.
DNOW (DNOW)
Market Cap: $2.49 billion
Spun off from National Oilwell Varco, DNOW (NYSE: DNOW) provides distribution and supply chain solutions for the energy and industrial end markets.
Why Are We Cautious About DNOW?
- Day-to-day expenses have swelled relative to revenue over the last five years as its operating margin fell by 6.9 percentage points
- Issuance of new shares over the last two years caused its earnings per share to fall by 13.9% annually while its revenue grew
- Eroding returns on capital from an already low base indicate that management’s recent investments are destroying value
DNOW’s stock price of $12.79 implies a valuation ratio of 0.5x forward price-to-sales. To fully understand why you should be careful with DNOW, check out our full research report (it’s free).
German American Bancorp (GABC)
Market Cap: $1.70 billion
Founded in 1910 during a wave of community banking expansion in the Midwest, German American Bancorp (NASDAQ: GABC) is a financial holding company that provides banking, wealth management, and insurance services across southern Indiana and Kentucky.
Why Does GABC Fall Short?
- Efficiency ratio is projected to stay flat over the coming year, suggesting its fixed cost leverage is currently maxed out
- Performance over the past two years shows its incremental sales were less profitable, as its 2% annual earnings per share growth trailed its revenue gains
- Capital trends were unexciting over the last five years as its 1.5% annual tangible book value per share growth was below the typical banking firm
At $48.10 per share, German American Bancorp trades at 1.4x forward P/B. Check out our free in-depth research report to learn more about why GABC doesn’t pass our bar.
Ingredion (INGR)
Market Cap: $6.36 billion
Known for its ability to turn ordinary corn into thousands of different food ingredients, Ingredion (NYSE: INGR) transforms grains, fruits, vegetables and other plant-based materials into specialty starches, sweeteners and other ingredients for food, beverage and industrial markets.
Why Is INGR Not Exciting?
- Products have few die-hard fans as sales have declined by 4.2% annually over the last three years
- Demand will likely be soft over the next 12 months as Wall Street’s estimates imply tepid growth of 1.7%
- Free cash flow margin shrank by 7.1 percentage points over the last year, suggesting the company is consuming more capital to stay competitive
Ingredion is trading at $95.64 per share, or 8.4x forward P/E. If you’re considering INGR for your portfolio, see our FREE research report to learn more.
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