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.

Picking the right small caps isn’t easy, and that’s exactly why StockStory exists - to help you focus on the best opportunities. That said, here are three Russell 2000 stocks to avoid and better alternatives to consider.

Grocery Outlet (GO)

Market Cap: $1.57 billion

Due to its differentiated procurement and buying approach, Grocery Outlet (NASDAQ: GO) is a discount grocery store chain that offers substantial discounts on name-brand products.

Why Is GO Not Exciting?

1. Responsiveness to unforeseen market trends is restricted due to its substandard operating margin profitability
2. ROIC of 2.2% reflects management’s challenges in identifying attractive investment opportunities, and its shrinking returns suggest its past profit sources are losing steam
3. Depletion of cash reserves could lead to a fundraising event that triggers shareholder dilution

Grocery Outlet’s stock price of $15.72 implies a valuation ratio of 19.7x forward P/E. To fully understand why you should be careful with GO, check out our full research report (it’s free).

J&J Snack Foods (JJSF)

Market Cap: $1.87 billion

Best known for its SuperPretzel soft pretzels and ICEE frozen drinks, J&J Snack Foods (NASDAQ: JJSF) produces a range of snacks and beverages and distributes them primarily to supermarket and food service customers.

Why Are We Wary of JJSF?

1. Smaller revenue base of $1.6 billion means it hasn’t achieved the economies of scale that some industry juggernauts enjoy
2. Estimated sales growth of 1.6% for the next 12 months implies demand will slow from its three-year trend
3. 2.7 percentage point decline in its free cash flow margin over the last year reflects the company’s increased investments to defend its market position

J&J Snack Foods is trading at $97.77 per share, or 18x forward P/E. Check out our free in-depth research report to learn more about why JJSF doesn’t pass our bar.

American Outdoor Brands (AOUT)

Market Cap: $110.1 million

Spun off from Smith and Wesson in 2020, American Outdoor Brands (NASDAQ: AOUT) is an outdoor and recreational products company that offers outdoor and shooting sports products but does not sell firearms themselves.

Why Do We Steer Clear of AOUT?

1. Sales trends were unexciting over the last five years as its 2.6% annual growth was below the typical consumer discretionary company
2. Earnings per share have dipped by 34.3% annually over the past four years, which is concerning because stock prices follow EPS over the long term
3. Shrinking returns on capital from an already weak position reveal that neither previous nor ongoing investments are yielding the desired results

At $8.70 per share, American Outdoor Brands trades at 7.5x forward EV-to-EBITDA. Read our free research report to see why you should think twice about including AOUT in your portfolio.

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