Finding Gems as Investors Ditch Small Caps

NEW YORK (TheStreet) -- Small-cap stocks have been taking a beating lately as the markets grapple with growing sentiment that we are overdue for a correction.

While the S&P 500 Index is up about 2% year to date, the S&P Small Cap Index is down about 3.6% and Russell 2000 Index has fallen 5.4%. Performance is worse in the even smaller companies that comprise the Russell Microcap Index, which is down more than 9% year to date.

That is typical behavior during times of market uncertainty as investors first jettison what they perceive to be the smaller and riskier stocks before they turn on the bigger companies.

Reactions can be fast and furious, and that's exactly what we've been seeing lately during this earnings season.

Take snowmobile and all-terrain vehicle manufacturer Arctic Cat (ACAT). The stock fell almost 13% yesterday after the company reported that revenue fell about $9 million short of the $154 million average estimate of analysts, and earnings came up a penny short.

The company also lowered its sales and earnings forecast for 2015 to below analysts' levels, and so it was not unexpected that the stock would be hit fairly hard.

Just four months ago, this was a $59 stock. Now trading in the $34 range, it has suffered a 42% haircut since January.

Yesterday's lowered company earnings estimate for 2015 of $2.33 to $2.34 per share -- and that excludes the effect of an unfavorable Canadian currency impact of 79 cents a share -- puts the forward price-to-earnings ratio at 14.

While the company also lowered revenue estimates, I'm not sure Arctic Cat's punishment fits the crime. That's exactly what you start to see when investors become nervous, and it may be the type of environment in which we'll begin to see more bargains appear, if the selling becomes irrational.

In terms of Arctic Cat, what went unnoticed by the market was the 25% dividend hike, which took quarterly distributions from to 12.5 cents a share from 10 cents. That shows me that management has confidence in the business, despite some short-term noise.

Arctic Cat's balance sheet remains strong. The company ended the quarter with $82.5 million, or $6.30 per share, in cash and no debt. Furthermore, the company has continued to buy back stock and has reduced shares outstanding by 31% since 2008.

The next several months may be an interesting time to pick up some smaller stocks on the cheap, especially if investors irrationally sell out of quality companies as fears of a correction build.

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At the time of publication, the author held no positions the stock mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff. No position

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