Where Investors Found Double-Digit Growth in Q1
Where Investors Found Double-Digit Growth in the First Quarter
(Note: companies that could be impacted by the content of this article are listed at the base of the story [desktop version]. This article uses third-party references to provide a bullish, bearish, and balanced point of view; sources are listed after the Balanced section.)
“People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game.”- Peter Lynch
Twenty years ago today, the above quote was first published (April 3, 2000). The book, One Up On Wall Street: How To Use What You Already Know To Make Money In The Market, was written by Peter Lynch. Lynch’s renowned credibility comes from having been the fund manager of the best performing mutual fund, Fidelity Magellan from 1977-1990. The wisdom and thought processes in these sentences and throughout his common-sense book written to help self-directed investors are as useful today as they were 20-years ago.
Size and the Impact on Price Moves
This best-seller also speaks of this reality, “Big companies have small moves, small companies have big moves.” This is true, but be warned, it is true on both the upside and the downside. During the first quarter of 2020, the performance for all major stock market indexes was down. This, of course, was exacerbated by the manmade slowdown in response to an unexpected deadly disease. When comparing Q1 2020 results of an index that aggregates large company performance versus an index that contains smaller companies this “big moves” reality, proves itself.
The S&P 500, which is a market-cap-weighted index of the 500 largest U.S. publicly traded companies, was down 20% over the quarter. The S&P 600 which is a benchmark for small-cap companies was down 32.94% during the same period. This shows that the downmarket caused a larger move of the small-cap index of almost 13%. Mr. Lynch was correct.
Maintaining the same logic, among the gainers of the small-cap companies listed in the S&P 600, there should be greater gains than in the S&P 500 large-cap index. This expectation held true as well.
While an investment in the top three performers in the small-cap index grew; 76.98%, 56.90%, and 55.75%, the best performer in the S&P 500 had growth of only 30.04%. The return places this large-cap top-performer eighth if it were measured among the S&P 600 companies. In fact, there is a total of 15 small-cap companies that rewarded holders with double-digit returns for the period. The large-cap index had only nine. So, Lynch’s advice holds true on both the winners and losers within the indices when measuring the magnitude of the gains and losses. This also demonstrates that investors looking for a better return (regardless of capitalization) have more potential selecting stocks, not buying an entire index. The largest opportunities for oversized gains and the largest returns Q1 were in small-cap stocks.
S&P 600 Small-Cap Index
The S&P 600 is a benchmark index for small-cap stock defined as $450 million to $2.10 billion. This range prevents overlap with the S&P 500.
Small-Cap 10%-Plus Gainers
The heightened awareness of the growing pandemic during the period certainly influenced company results. Almost all of the 15 stocks returning over 10%, included companies that stand to benefit from either an increased need for their product or service or speculation that they may benefit greatly. The industry categories of the big winners included: health, communications, internet, and one company that manufactures guns and ammunition. Many of the companies straddled two of these industries which could have added to their appeal. Examples of these include an online health information provider, an online pet pharmaceutical company, one of the telecommunications companies has a large wireless division, while the other has IT services and provides entertainment. The common thread, as one might expect, is that companies that are seeing more demand for their products (and can deliver) got investor attention.
S&P 500 Large Cap Index
The S&P 500, is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
Large-Cap 10%-Plus Gainers
As mentioned, the large-cap stocks have far fewer double-digit gainers compared to the small-cap companies, and the best performed less than half as well. Their business lines are similar to what was experienced in the smaller companies. They include products or services where one might expect to see a sales uptick during the stay-at-home and wait-for-a-cure environment that we find ourselves in. This gainers also includes a “pure-play” in disinfectant products and containers, while another is a “pure-play” in-home entertainment.
As the quarterly earnings reports are made available, we will likely find most of these companies have experienced significantly higher dollar increases in revenue than the better performing small-cap winners. This shouldn’t equate to higher stock prices. As a percent of revenue, large-cap companies have a much higher growth hurdle. This is because with their larger size and market share it is harder to have a more impactful increase. Another reason large-caps don’t move as aggressively is that they are usually more diversified. Large companies often have many more business lines, this causes them to be less likely to experience explosive growth across all products. This also makes them more difficult for investors to understand. Two of the largest gainers in the large-cap index (a home entertainment company and home disinfectant giant) experienced their moves because their business concentration is both in demand and at the same time easily understood.
What to do in Q2
When the economy is business-as-usual and there is little disruption, the market is most efficiently priced. Finding value or finding the next big mover is much more difficult. Alternatively, when business is changing rapidly, opportunity exists for those paying attention and also have the confidence to act.
“Invest in what you know” is another quote attributed to Peter Lynch. He described this as meaning, “Use your specialized knowledge to home in on stocks you can analyze, study them and then decide if they’re worth owning.” We’re now in the second quarter, within each of our newly disrupted lives we are seeing many changes. Some of what we’re seeing and doing will hold and become the new norm. Most should revert to what we had before. This creates opportunity with both the “new norm” and with depressed businesses recovering to provide investors with above-average growth.
Think about what will stick and what will change back after the pandemic is over. Weigh this alongside what you know and are seeing. For example, we’re seeing large quantities of stimulus which won’t be mopped up soon. When the crisis is over who will continue to prosper with the excess liquidity? Another obvious example is government spending on infrastructure, will it help government contractors to prosper. Then ask, who are the smaller providers that will gain the most? Is there reason to believe the oil production deal between the Saudis and the Russians will fall apart? When the pandemic subsides, demand for oil will increase, how big is the current glut and how long does it usually take to turn the spigot back on? These are just examples of how to start. To get informed answers to your questions there are places to uncover expert unbiased analysis. Channelchek is one source that provides research by a team of fiercely unbiased veteran analysts. It’s a no-cost tool that covers many of the most CoVID-19 impacted sectors.
Peter Lynch once lamented, “People buy a stock and they know nothing about it,” he continued “That’s gambling and it’s not good.” During the second quarter of 2020, opportunities may be at their peak, develop your industry and company hypothesis, then research.
Registered users of Channelchek have free and unlimited access to small-cap research and industry reports. If you have not yet registered, you’re missing insights that could lead you to better portfolio performance. Register now, it’s easy.
Paul HoffmanManaging Editor