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James Dennin, Kapitall: This year small cap stocks – market cap between $300 million and $2 billion – grew twice as fast as the market.
There have been mixed signs from the economy this fall. Unemployment numbers have been static, US factory output increased slower than expected, and a number of important American companies like
IBM (IBM) and
Caterpillar (CAT) missed their earnings estimates looking ahead into the next year.
[Read more from Kapitall: Deal or No Deal: 6 Stocks Under 5 Dollars Trading Below Book Value]
Which begs the question, what sort of recovery this is, exactly? Economic growth has been the slowest it's been since during World War II. And yet, amidst all the lukewarm and confusing news, a
Bloombergstudy of the year's economic data has given economists one cause for optimism.
Over the last year, small cap stocks have grown at double the rate of larger companies – and that's an important statistic for a number of reasons.
For one, smaller companies generally tend to do most of their business domestically. The fact that investors are moving their money into stocks that get their profits from the US indicates a greater level of confidence domestically.
On top of that, in three of the four times that this situation has occurred, robust growth for small cap stocks led to greater growth for the economy as a whole in the following year.
Small cap stocks are usually growth stocks. They are unlikely to pay dividends, and they often have less economic data available than larger companies who have been around longer. Investors usually look for small cap stocks that have a lot of room to grow, as that's where they are most likely to see a return on their investment.
We decided to screen for small cap stocks using two major parameters: strong
sales growth over the last 5 years, and projected
earnings per share (EPS) growth over the next 5 years above 20% – a sign of high growth in the future.
Since companies can fix their balance sheets in the short term by borrowing money, we also wanted to make sure that these stocks weren't holding too much debt – in this case under $0.30 cents on the dollar as indicated by their
long-term debt to equity ratio (LT Debt/Equity).
We were left with six stocks on our list.