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.

Sweetgreen (SG)

Market Cap: $656.9 million

Founded in 2007 by three Georgetown University alum, Sweetgreen (NYSE: SG) is a casual quick service chain known for its healthy salads and bowls.

Why Are We Out on SG?

1. Lagging same-store sales over the past two years suggest it might have to change its pricing and marketing strategy to stimulate demand
2. Free cash flow margin dropped by 11.5 percentage points over the last year, implying the company became more capital intensive as competition picked up
3. Limited cash reserves may force the company to seek unfavorable financing terms that could dilute shareholders

Sweetgreen is trading at $5.64 per share, or 319.6x forward EV-to-EBITDA. Dive into our free research report to see why there are better opportunities than SG.

Planet Fitness (PLNT)

Market Cap: $6.49 billion

Founded by two brothers who purchased a struggling gym, Planet Fitness (NYSE: PLNT) is a gym franchise that caters to casual fitness users by providing a friendly and inclusive atmosphere.

Why Do We Pass on PLNT?

1. Disappointing same-store sales over the past two years show customers aren’t responding well to its product selection and in-store experience
2. Capital intensity will likely increase as its free cash flow margin is anticipated to drop by 2.6 percentage points over the next year
3. Diminishing returns on capital from an already low starting point show that neither management’s prior nor current bets are going as planned

Planet Fitness’s stock price of $81.68 implies a valuation ratio of 24.1x forward P/E. To fully understand why you should be careful with PLNT, check out our full research report (it’s free).

Avis Budget Group (CAR)

Market Cap: $3.38 billion

The parent company of brands such as Zipcar and Budget Truck Rental, Avis (NASDAQ: CAR) is a provider of car rental and mobility solutions.

Why Does CAR Worry Us?

1. Products and services are facing significant end-market challenges during this cycle as sales have declined by 1.5% annually over the last two years
2. Shrinking returns on capital suggest that increasing competition is eating into the company’s profitability
3. Depletion of cash reserves could lead to a fundraising event that triggers shareholder dilution

At $95.70 per share, Avis Budget Group trades at 25.1x forward P/E. If you’re considering CAR for your portfolio, see our FREE research report to learn more.

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