In 2018, the financial markets have been good to small cap investors. Trade war fears have generated higher volatility levels in the benchmarks and many large-cap companies with international exposure have fallen from their highs. In this sense, small-cap stocks have been used as something of a “safe haven” and their valuations have surged in the process.
However, this may also seem counterintuitive, given the higher levels of risks that are associated with small-cap companies during most other market environments. Does this mean small-cap investors are at risk for major losses heading into 2019?
Recent activity in a few key names suggests that this may be the case. These risks have also become evident in the broader benchmarks, as the Russell 2000 has significantly underperformed the S&P 500 since bearish volatility became more apparent after the summer trading period.
One example of a high-flying small-cap stock, which now finds itself in danger of reversal, is Crocs, Inc. (NASDAQ:CROX). The stock has surged by a massive 112.10% so far this year as global demand for its inexpensive shoe offerings has remained relatively stable. These trends may turn out to be a double-edged sword, however, as they suggest that the domestic security of the small-cap stock stems largely from shielded foreign exposure.
CROX is currently trading with a mind-boggling price-to-earnings (P/E) ratio of 233.61. This puts the stock’s valuation at almost three-times the levels seen with Amazon, Inc. (NASDAQ:AMZN), which currently trades with a P/E of 94.62. If markets to begin to experience a slowdown in consumer spending, surging stocks like CROX could be in jeopardy. Over the longer-term, it is hard to avoid the impact of rising trends. For example, as 3-D printing becomes more available and less expensive, how will a company like Crocs, Inc. manage these risks? This suggests short-sellers may find opportunities for positioning after these latest rallies in the CROX share price.
Another name which could be poised for deep declines is Quantenna Communications, Inc. (NASDAQ:QTNA). The stock has posted rallies of 38.52% so far this year. However, the company’s WI-FI platform businesses will likely require support from video entertainment and telecom providers like AT&T, Inc. (NYSE:T) in order to fully recognize the platform capabilities. But, the telecommunications industry is currently one of the most overvalued sectors in the market (trading at 22.6x TTM earnings).
Companies like AT&T must also account for significant expenditures (which have been made recently in the deal to acquire Time Warner). Ultimately, this could limit expansionary projects going forward and reduce the potential for new contracts for smaller players like Quantenna Communications. As a result, QTNA bulls could suffer a significant one-two punch if small-cap benchmarks revert to their historical averages and if bearish volatility continues within the broader equities market. Current analyst projections are calling for elevated revenue growth in 2018 for Quantenna Communications. But, if those earnings fail to materialize, QTNA could see a significant decline from its current levels.
Disclaimer: The author and Spotlight Growth has no positions in any of the stocks mentioned in this article. Nor does either party currently have any relationship, or any other conflicts of interest, with any of the companies mentioned in this article. This content is meant for informational and entertainment purposes only and should not be meant as a recommendation to buy or sell any securities. Please visit a licensed financial representative to determine what investments are right for you.
Article By: Ric Cox