Small Cap Standouts Ride Rising Earnings through Market Troubles

By Jeff James

Early 2018 looked much like a continuation of 2017 as equity prices rallied, optimism expanded and valuations kept climbing. Since the market's late January peak though, investors have been hit with numerous concerns causing stocks to churn sideways over the past several months.

A partial list of market worries include: elevated valuations, higher inflation, rising interest rates, the flattening yield curve, the trade proposals/policy/war, a stronger dollar, peak earnings, cyclical peaks, “too much good news”, and “it can’t get any better.” While each of these can be debated, the one constant that has been present has been robust corporate earnings.   

The following points illustrate how strong the earnings environment currently is:

  • S&P 500 earnings are now expected to be up 19.8% in 2018 and up 25% year-over-year for the March quarter.  In addition, earnings are expected to expand at a double digit rate in 2019.
  • Russell 2000 earnings are expected to be up 28% in 2018, above the growth rate of large caps.
  • Importantly, the earnings growth is not just related to tax cuts. The stronger U.S. and global economies are boosting revenue growth to over 7% this year for both the Russell 2000 and the S&P 500. 

As we construct our portfolios and select new investment ideas, we continue to witness first-hand the rising level of earnings occurring in this market. Our portfolios are full of differentiated companies with superior fundamentals and robust outlooks, and a number of these businesses are experiencing major earnings inflection points.

In the consumer discretionary space, a leading manufacturer of golf equipment and apparel has enjoyed dramatic fundamental improvement as new products enhance its leadership position in the golf industry. The accompanying earnings surge doesn't even take into account the company's stake in a private high-tech driving range and entertainment venue that represents a significant "hidden asset" not priced into the stock.

Another company we own makes non-deadly weapons used by police officers across the US, but has also managed a transition to supply wearable cameras and other evidence recording technologies to law enforcement departments around the world. Years of heavy R&D have paid off as the company has dramatically turned into a technology company with recurring revenues growing 70%, rapid earnings growth and has won the vast majority of market share with police departments globally.

In the healthcare sector, breakthroughs from an efficacy or technology standpoint can have a tremendous impact on company earnings. One example is a maker of Portable Oxygen Concentrators, which are technologically superior, lightweight and mobile solutions for patients with chronic repository conditions.  The company, with its disruptive solution, is the dominant market leader, posting 51% revenue growth in its March quarter with earnings up 78%.and signaling sustained growth for years to come.

In a market with plenty to worry about, small cap companies like these are still offering compelling opportunities to own strong businesses with years of sustainable growth in their future.



This information is not intended to provide investment advice. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, market sectors, other investments or to adopt any investment strategy or strategies. You should assess your own investment needs based on your individual financial circumstances and investment objectives. This material is not intended to be relied upon as a forecast or research. The opinions expressed are those of Driehaus Capital Management LLC (“Driehaus”) as of April 2018 and are subject to change at any time due to changes in market or economic conditions. The information has not been updated since April 2018 and may not reflect recent market activity. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Driehaus to be reliable and are not necessarily all inclusive. Driehaus does not guarantee the accuracy or completeness of this informa¬≠tion. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.