Investing in the stock market appears to be an easy task on the surface. After all, all that you have to do is to buy shares right? Well, it is this easy if one were to randomly buy stock and hope that the price increases. However, investing after conducting research is slightly trickier. There are thousands of stocks to choose from, and they are divided into categories based on their fundamentals and market statistics.
Two of these metrics are market capitalization and value. The former is relatively easy to comprehend. A market capitalization is simply the total worth of a firm's shares on the stock market. Stocks are divided into five categories by the Financial Industry Regulatory Authority (FINRA) - a self regulator of brokerages. These are micro cap, small cap, mid cap, large cap, and mega cap. Delving a bit deeper into the details, a micro-cap stock is one whose market capitalization is less than $250 million, while mega-cap stocks, such as Apple Inc. (NASDAQ:AAPL) and Microsoft Corporation (NASDAQ:MSFT), are those with a market capitalization exceeding $200 billion.
Another category, small cap, is of firms whose capitalization ranges between $250 million and $2 billion. While on the surface these stocks naturally are not as appealing as for instance, Apple, investing in them has its own set of benefits. Companies like Apple and other technology behemoths are here today because while they too were once small caps, strong business models and lucrative market growth have funneled investor funds into them. Yet, their size often makes outsized or large returns difficult unless the market as a whole is recovering. As an illustration, consider the fact that Apple's shares have returned 7% over the past twelve months while year to date the stock is up 35% after it whipsawed last year in a tumultuous environment for the technology industry.
On the small-cap front, while historically these stocks have provided a small premium over the stock market, the returns have not been consistent and have see-sawed. Research from Of Dollars and Data shows that since 1926, the U.S. stock market has delivered 7% in annual returns on average while small-cap stocks have offered a 1.4% premium by delivering an 8.4% return. Yet, since these percentage figures are for average returns, they smooth out the peaks and the troughs. A deeper analysis of the data shows that some periods saw them outperform the market by almost 13% while others saw them lag behind by as much as 7%. Additionally, the risk for these stocks, i.e. the standard deviation, was higher than the market as a whole since it stood at 32% compared to the 21% for the broader market.
Building on this, one of the more popular U.S. small-cap market indexes, the Russel 2000 is 12.9% over the past five years and 216% since 2004. At the same time, the S&P 500 is up 56.5% over the past five years and 276% since 2004. This confirms the volatility of small-cap returns shared above, as while the S&P has widely outperformed the Russel 2000 over a shorter time horizon, over the long term, the returns almost seem to converge. For an additional data point, the Dow Jones Industrial Average is up 40.54% over the past five years and by more than 300% since 2004.
Shifting our focus to value stocks, these are stocks typically thought of as ones that have failed to capture market attention and are sold cheaper compared to the earnings that they bring to the income statement. The billionaire founder of Fisher Investments Mr. Ken Fisher has some timeless insights about these stocks and what to look for and what to avoid when investing in them:
Since well before I was born, people regularly ponder what's a better investment? Growth stocks, or value stocks? Now some of this about the stocks, and some of this is about you, or the person that would entertain the question. Simply, in the very long term, growths and value do the same, really similarly. By that I mean the very long term. Neither one is particularly better, because in the long term shifts in supply of equity of any category including growth and value will overwhelm any shifts in demand for the category. In my Only Three Questions book, I wrote basically a whole chapter on that topic. How supply overwhelms demand for any category including growth and value.
With these details in mind, let's take a look at some small-cap value stocks being favored by hedge funds. Some top picks are Warrior Met Coal, Inc. (NYSE:HCC), SandRidge Energy, Inc. (NYSE:SD), and Gray Television, Inc. (NYSE:GTN).
10 Best Small Cap Value Stocks to Invest In
Our Methodology
To compile our list of the best small-cap value stocks, we first listed all stocks with a price to earnings ratio lower than five and a market capitalization between $300 million and $2 billion. Then, the ones with the lowest P/E were selected for an initial list of 50 stocks. After this, the number of hedge fund investors in them as of Q4 2022 courtesy of Insider Monkey's survey was determined, and the top ten small-cap value stocks are listed below.
Beazer Homes USA, Inc. (NYSE:BZH) is a construction company based in Atlanta, Georgia. The firm builds and sells single family and multi family homes.
20 of the 943 hedge funds part of Insider Monkey's Q4 2022 survey had invested in Beazer Homes USA, Inc. (NYSE:BZH). The firm's largest investor is Israel Englander's Millennium Management with a $12 million stake.
Along with Warrior Met Coal, Inc. (NYSE:HCC), SandRidge Energy, Inc. (NYSE:SD), and Gray Television, Inc. (NYSE:GTN), Beazer Homes USA, Inc. (NYSE:BZH) is a top small-cap value stock.
Ferroglobe PLC (NASDAQ:GSM) is a British company headquartered in London, United Kingdom. The firm provides silicon products for use in a variety of different products such as personal care items, healthcare products, steel production, electronics, and others. Ferroglobe PLC (NASDAQ:GSM) also operates quartz mines in North America and Europe.
By the end of last year's fourth quarter, 20 of the 943 hedge funds polled by Insider Monkey had held a stake in the company. Out of these, Ferroglobe PLC (NASDAQ:GSM)'s largest shareholder is Israel Englander's Millennium Management since it owns 5.4 million shares that are worth $20 million.
W&T Offshore, Inc. (NYSE:WTI) is an oil and gas company headquartered in Houston, Texas. The firm is an offshore oil and gas firm, with production facilities in the Gulf of Mexico. It also sells oil, gas, and other petroleum products.
Insider Monkey's fourth quarter of 2022 survey covering 943 hedge funds revealed that 21 had invested in W&T Offshore, Inc. (NYSE:WTI). The firm's largest investor in our database is D. E. Shaw's D E Shaw with a $12 million stake that comes via 2.2 million shares.
Berry Corporation (NASDAQ:BRY) is another oil and gas company. It is headquartered in Houston, Texas. The firm primarily develops oil and gas reserves in California and Utah. It also provides well maintenance and other services to oil and gas production companies.
By the end of December 2022, 21 of the 943 hedge funds profiled by Insider Monkey had held a stake in the company. Berry Corporation (NASDAQ:BRY)'s largest hedge fund investor is Howard Marks' Oaktree Capital Management since it owns 6.7 million shares that are worth $54 million.
LendingClub Corporation (NYSE:LC) is a financial services firm based in San Francisco, California. It provides deposit, loans, and other products. Along with Warrior Met Coal, Inc. (NYSE:HCC), SandRidge Energy, Inc. (NYSE:SD), and Gray Television, Inc. (NYSE:GTN), it is a small-cap value stock that hedge funds are piling into.
22 of the 943 hedge funds part of Insider Monkey's database had bought LendingClub Corporation (NYSE:LC)'s shares in Q4 2022. David Rosen's Rubric Capital Management is the largest investor with a $51 million stake.
