You’ve probably seeing a bunch of stories lately about how the stock market rally has become too narrow. What’s that mean? Simply put, a few mega-cap tech stocks are responsible for most of the market’s gains lately. If you own the huge tech names, it’s been great recently. But much of the market, and especially small stocks, has been left behind.
Some investors have decided to stop fighting the wave. No price is too high for something like Apple (NASDAQ:AAPL), apparently, as long as the momentum keeps going. Even an earnings warning could hardly keep Apple down.
At some point, though, the situation will flip. As a result, some investors are booking gains on their highly successful tech positions, and are rotating into other stocks that haven’t had huge rallies yet.
Historically, small capitalization stocks have outperformed the broad market over the years. And after a disappointing 2019, they may be ready to punch above their weight in 2020. Consider that the new coronavirus from China is having a disproportionate impact on Chinese companies, and American multinationals with a large presence in Asia. Meanwhile, smaller American firms are much less sensitive to the problems.
As such, this could be a great time to move some money out of overpriced high-fliers and pick up some small stocks while they’re still cheap.
Global Water Resources (GWRS)
If you’re thinking of exciting small-cap stocks, a utility probably wouldn’t be your first choice. But don’t be so quick to count out Global Water Resources (NASDAQ:GWRS). The $300 million market capitalization Arizona water utility is a fascinating company.
Right now, it’s fairly modest, as it serves only about 50,000 water taps. These are primarily in the Phoenix suburb of Maricopa. However, it, like Phoenix, is booming. Its customer base has nearly doubled since the Great Financial Crisis. Arizona is one of the fastest-growing states in the U.S., and Global Water Resources has focused its M&A activity on the fast-growing towns within the Phoenix metro area.
More growth will be on the way. The Nikola Motor Company announced plans to build a 1 million square foot facility to manufacture hydrogen vehicles at a newly-established Arizona inland port. Global Water will be handling the water logistics. The federal government also just showered the new inland port with $39 million in subsidies. This ensures that Global Water’s new project will obtain more paying utility customers quickly. It should lead to more new housing communities in its service area as well.
People have been recommending homebuilder stocks as a way to play the recovery of housing and the rising trend of millenials finally buying homes. And that’s a fine idea. But it’s one that comes with significant risk if the economy goes south. Global Water, by contrast, gives access to one of the nation’s hottest (literally and figuratively) housing markets without the downside risk if prices stall out again. People will keep using their water regardless of what the economy does, after all.
As an added kicker, Global Water pays a monthly dividend of 2.4 cents per share, which amounts to 2.1% annually. They also tend to hike the dividend annually. So if you’ve been looking for another monthly-payer dividend stock for your portfolio, give Global Water a look.
Catchmark Timber (CTT)
One nice thing about small-cap stocks is that you can get exposure to different types of assets. Many of these fly under the radar. Like Arizona water utilities, such as we just discussed. Or how about a pure-player timber holding company, in the form of Catchmark Timber (NYSE:CTT)? Yes, there are other timber REITs that are publicly-traded, but they invest in manufacturing and processing their wood products.
Catchmark, by contrast, only deals in owning timberlands directly. This makes the company a major inflation hedge, as you get pure commodity exposure to U.S. (primary southeastern) land holdings and, obviously, the price of timber going forward. While there will be plenty of bumps along the way for both, over time, like inflation, these should head solidly higher.
Why pick up Catchmark stock now? Shares have been relatively quiet for the last few years. This has left shares at a fair price now, with the timber player offering a 4.9% dividend yield. That’s a healthy dose of income from a stock that also serves as a robust inflation hedge for your portfolio.
New York Community Bancorp (NYCB)
If you like small stocks with big dividends, this next one packs an even bigger punch than Catchmark. New York Community Bancorp (NYSE:NYCB) offers a well-covered 6.1% dividend yield from its low-risk New York metro-area multi-family lending business. And, in fact, the bank just announced a fantastic quarter, and yet the share price actually dropped a few percent.
For years, the bank has been dogged by critics. They’ve complained about the bank’s falling profit margins, lack of growth, and a stale business model. That’s all changed for the better in recent months. For one, the government eased federal banking regulations, allowing NYCB to grow beyond the old $50 billion asset cap. This, for the first time since the financial crisis, will let New York Community Bancorp expand its balance sheet normally again.
On top of that, New York Community Bancorp has a sort of counter-cyclical loan book that didn’t benefit from higher interest rates immediately. Now, however, while other banks are seeing their margins plummet with Fed rate cuts, NYCB’s margins and EPS have just kicked into solidly positive territory. Even after delivering a fantastic quarter, critics have moved on to complaining about the bank’s exposure to New York City apartments. Local government there just changed rent control laws, and this has had a negative effect on local prices.
No matter though, NYCB lends less than 60% of the value of these properties so even a significant dip in housing prices won’t cause the bank losses. NYCB was one of the safest banks in the country in the 2008 crisis, and experienced essentially zero lending losses even then. It’s time to take advantage of the market’s inappropriate reaction to NYCB’s excellent earnings. The stock already yields 6.1%, and with earnings kicking into growth mode again, look for more share buybacks or a dividend hike in coming quarters. It also trades at just 13x earnings and is a buyout target as the CEO advances in age and may look for an exit strategy.
The ONE Group Hospitality (STKS)
The ONE Group Hospitality (NASDAQ:STKS) is a small restaurant operator primarily known for its STK steakhouses. These are a high-end concept, with the 14 ounce Dry-Aged Delmonico going for $74 at its Walt Disney World location, to give one example. Despite that, remarkably enough, STK historically had struggled to generate high enough profit margins at its restaurants.
However, things have turned around since new CEO Manny Hilario took over the reins at the end of 2017. STK has started reporting fantastic same store sales growth (high single digits) while at the same time bringing down overhead costs. The ONE Group’s stock price has tripled under Hilario’s watch.
And now he’ll get a shot at repeating his success. That’s because The ONE Group just acquired 24 Kona Grill restaurant locations out of bankruptcy. That company had infamously free-spending leadership and a muddled menu and corporate identity in recent years. Remarkably, Kona Grill had a market capitalization of $300 million as recently as 2015. Now, The ONE Group grabbed the best two dozen Kona Grill locations for just $36 million. That’s sizable discount to the cost of merely building the restaurants, let alone establishing the brand.
STKS stock is up from $1.50 to $4.50 in recent years under the new CEO’s excellent leadership. If he can help resuscitate Kona Grill, who knows how much higher the stock could go.
Rocky Mountain Chocolate Factory (RMCF)
Given all the attention on edibles lately, you would be forgiven for assuming that a Colorado packaged foods company had something to do with the cannabis market. But, at least for now, Rocky Mountain Chocolate Factory (NASDAQ:RMCF) instead sells premium chocolates at more than 300 stores including many co-branded Cold Stone Creamery locations. It also has a frozen yogurt brand, U-Swirl.
The company’s chocolate is indeed premium, bringing in an average retail price of more than $23 per pound. If you’re familiar with Warren Buffett’s history, he often cites his investment in See’s Candies as one of his finest investments. It’s repaid its original purchase price many times over by now. That’s because the economics of chocolate are simply fantastic. You get massive profit margins.
Rocky Mountain Chocolate Factory shares in that bounty with shareholders, paying a 6% dividend yield. Alas, due to strategic missteps, such as errors with the yogurt brand, the company’s profits and share price have struggled in recent years. However, an activist has come in to shake the company up and new people have joined the board. Further to that point, the company has just launched a major partnership with Edible Arrangements to sell its chocolates at more than 1,000 Edible Arrangements stores. This should boost utilization at Rocky Mountain’s Colorado factory and get profits on the upswing again.
OrthoPediatrics (KIDS)
This last pick is a bit more speculative than some of the others on the list, as it isn’t quite profitable yet. But it’s growing at a fast clip and is going after a market niche – medical devices for children – that has historically had great economics.
OrthoPediatrics (NASDAQ:KIDS) offers a two-dozen product line that covers trauma and deformity, scoliosis, and sports medicine related issues for children. Shares have already tripled since the 2017 initial public offering, and it’s not hard to see why. The company has been delivering steady 25%+ annual revenue growth, and they recently turned positive on an EBITDA basis, though they are still reporting EPS losses.
With a medical device company like this, however, so much of the cost base is in marketing and overhead. Oftentimes, these companies will sell for huge multiples to larger medical device companies. Those companies can, in turn, immediately earn huge synergies. They do this by cutting duplicate costs and distributing the products through their far larger distribution channels.
As long as OrthoPediatrics continues putting up strong revenue growth and scoring FDA approval for new products, as it did on multiple occasions in 2019, the stock price should continue to soar.
Empire State Realty (ESRT)
Saving the biggest of the small companies for last, we have one of the world’s largest buildings. That’s right. Did you know you could own a piece of the Empire State Building? The Empire State Realty Trust (NYSE:ESRT) owns the Empire State Building along with a portfolio of other office buildings in the New York City metro area.
Shares have dropped from $20 to $14 in recent years. This has been for several reasons. For one, there’s currently a weak office market in New York City. The “retail apocalypse” has also caused more storefront vacancies in Manhattan, where Empire State has a large presence; its buildings have retail on the ground level. Finally, the trade war – and now coronavirus – are lowering the inflow of tourists to New York. Those are tourists, who, in turn, drop tons of money at the Empire State Building Observatory and related attractions.
That Observatory is a key element of the bull thesis. Its revenues have been growing for 10% a year over the past two decades. That’s even despite the 9/11 attacks, the Financial Crisis, and other setbacks. With the rise of Instagram (NASDAQ:FB) culture and experiences, top-notch tourist attractions like the Empire State Building are one-of-a-kind properties and will enjoy rising values in coming years as investors seek to find trophy assets. With shares down 30% in recent years, this apple is ripe for the picking.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned CTT, ESRT, NYCB, GWRS, and FB stock.