The Russell 2000 (^RUT) is home to many small-cap stocks, offering investors the chance to uncover hidden gems before the broader market catches on. However, these companies often come with higher volatility and risk, as their smaller size makes them more vulnerable to economic downturns.

Navigating this part of the market can be tricky, which is why we built StockStory to help you separate the winners from the laggards. That said, here are three Russell 2000 stocks to avoid and better alternatives to consider.

The Cheesecake Factory (CAKE)

Market Cap: $2.29 billion

Celebrated for its delicious (and free) brown bread, gigantic portions, and delectable desserts, Cheesecake Factory (NASDAQ: CAKE) is an iconic American restaurant chain that also owns and operates a portfolio of separate restaurant brands.

Why Are We Wary of CAKE?

1. Disappointing same-store sales over the past two years show customers aren’t responding well to its menu offerings and dining experience
2. Estimated sales growth of 3.9% for the next 12 months implies demand will slow from its six-year trend
3. High net-debt-to-EBITDA ratio of 6× could force the company to raise capital at unfavorable terms if market conditions deteriorate

At $46.49 per share, The Cheesecake Factory trades at 11.6x forward P/E. Read our free research report to see why you should think twice about including CAKE in your portfolio.

Portillo's (PTLO)

Market Cap: $339.5 million

Begun as a Chicago hot dog stand in 1963, Portillo’s (NASDAQ: PTLO) is a casual restaurant chain that serves Chicago-style hot dogs and beef sandwiches as well as fries and shakes.

Why Do We Pass on PTLO?

1. Poor same-store sales performance over the past two years indicates it’s having trouble bringing new diners into its restaurants
2. Investment activity picked up over the last year, pressuring its weak free cash flow margin of -0.9%
3. Depletion of cash reserves could lead to a fundraising event that triggers shareholder dilution

Portillo's is trading at $4.71 per share, or 23.9x forward P/E. Check out our free in-depth research report to learn more about why PTLO doesn’t pass our bar.

Denny's (DENN)

Market Cap: $317.7 million

Open around the clock, Denny’s (NASDAQ: DENN) is a chain of diner restaurants serving breakfast and traditional American fare.

Why Do We Steer Clear of DENN?

1. Disappointing same-store sales over the past two years show customers aren’t responding well to its menu offerings and dining experience
2. Smaller revenue base of $457.2 million means it hasn’t achieved the economies of scale that some industry juggernauts enjoy
3. 5× net-debt-to-EBITDA ratio makes lenders less willing to extend additional capital, potentially necessitating dilutive equity offerings

Denny’s stock price of $6.17 implies a valuation ratio of 15.1x forward P/E. If you’re considering DENN for your portfolio, see our FREE research report to learn more.

Stocks We Like More

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