4 Small-Cap Stocks to Consider Amidst the Downturn

When it comes to the latest financial panic, the smaller they are, the harder they fall.

The little cap

Russell 2000

has been decimated over the past two weeks – and it’s not hard to see why. About 17% of the index is in financial stocks, and with every little bank under the sun facing scrutiny these days, investors are opting to sell first and ask questions later. As a result, the Russell is down 8%, against a 2% drop in the

S&P 500.

since 3 March.

That seems extreme — and it could be an opportunity for investors willing to search for baby banks that have been thrown out with the bathwater. There are plenty of targets — many of the more than 200 bank stocks in the Russell have fallen by double digits in recent weeks. The question is, which ones to buy?

Phillip Cook, co-chief investment officer at SouthernSun Asset Management, points to Live Oak Bancshares (ticker: LOB). Shares of the Wilmington, N.C.-based institution have lost about a quarter of their value this month, though it is a very different animal than the troubled regional banks. Live Oak, which had $9.9 billion in assets at the end of 2022, is focused on lending to small businesses, and many of its loans are guaranteed by the federal government, meaning lower risk of loss due to default.

Cook sees the bank gaining market share in a potential recession as other lenders pull back from lending to small businesses. About 42% of Live Oak’s loan book is government-backed, compared to 3% for the US banking sector overall.

Advertisement – Scroll to continue

Investors don’t have to stick to traditional banks to find opportunities. Pullen Investment Management’s Tyler Pullen points to trading firm and market maker Virtu Financial ( VIRT ) benefiting from increased market volatility. The company has been under fire lately from the Securities and Exchange Commission, which has proposed rules targeting pay-for-order-flow practices.

That has caused Virtu’s stock to fall 13% this year and diverge from a rising VIX – which it usually tracks closely, according to Pullen. He expects the financial impact on Virtu of potential SEC regulation to be manageable and market volatility to remain high in 2023, as is typical around changes in Fed policy and recessions.

Pullen also likes the Federal Agricultural Mortgage (AGM), colloquially known as Farmer Mac. It’s a government-sponsored company similar to Fannie Mae or Freddie Mac: It buys farm-related loans from banks and other lenders, securitizes them, and sells them to other investors. The stock has been caught up in the bank sale and is down 15% in two weeks. Pullen sees Farmer Mac solving a real need for farmers that is government-supported, has solid organic lending growth and isn’t tied to Silicon Valley, mortgages or consumer credit.

“Credit events in this space are few and far between, and the farm security is a good asset,” he says.

Even non-financial small-caps have been hit hard. SouthernSun’s Cook calls Darling Ingredients

Advertisement – Scroll to continue

(DAR), which has the unglamorous business of taking the scraps of the meat processing industry and turning them into proteins and fats that can be used elsewhere.

The growing demand for sustainable fuels has been a tailwind for Darling, which converts some of the residues into renewable diesel and jet fuel. It also makes raw materials for animal feed and human consumption, such as collagen supplements.

However, the Darling stock has been dragged down more than 20% this month due to the drop in oil and other commodity prices. But the company doesn’t sell gasoline — demand for its fuels is driven more by regulations and environmental concerns than economic activity, Cook says.

Advertisement – Scroll to continue

Darling stock seems to have been trashed by a market that doesn’t pay much attention to fundamentals. It’s a ripe time to fish for bargains.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top
%d bloggers like this: