Russell 2000 index
is widely seen as a
for small cap stocks. Yet the definition of "small cap" can be
Riverbed Technology (Nasdaq: RVBD)
, the Russell 2000's largest component, is worth more than $4
billion, while a number of members of theindex are worth less than
$200 million. Historically, the biggest names in thisindex
eventually graduate, often to the S&P 500, where they become
one of the smaller companies in this large companyindex . Such a
move often triggers a nice little gain, asindex funds need to buy
up shares of any new S&P 500 entrants to ensure that they own
the whole portfolio.
So which stocks are most likely to graduate and matriculate
upwards? Let's take a look.
To gain inclusion in the S&P 500, decision-makers at Standard
& Poor's like to ensure that new entrants have a reasonable
level of current business and a bright future. Here's a look at the
top 10 companies in the Russell 2000 in terms of
, along with their current sales base and projected growth rates
Now, let's take a look at the smallest 10 members of the S&P
500 by market value. Every one of them is worth less than the 10
Russell 2000 components noted above. Yet by annual sales, most of
the S&P 500 stocks are far larger, with several sporting annual
sales in excess of $10 billion.
To be sure, Standard & Poor's isn't looking to actively boot
any of these companies out of the S&P 500. They only do that
when a company is acquired, moves its headquarters offshore, or
slips into bankruptcy. (Ironically, clothing maker
, noted earlier in the Russell 2000 table was once in the S&P
500 before it went into bankruptcy). What S&P wants is a
company that helps maintain a balanced exposure to various aspects
of the U.S.economy . So if an industrial firm exits, another
industrial firm is likely to take its place.
The S&P 500's next freshman class
Looking at potential candidates, Riverbed Technology looks like the
most logical choice simply because of its $4 billion market value
and fast-rising sales base. Then again, the company's focus on data
storage management means that it could be a takeover candidate, as
M&A activity in that segment is white-hot. And the S&P is
unlikely to add a company that will soon be exiting theindex .
The company's stock has nearly tripled in value in the past year, a
possible turn-off at S&P, which tends to avoid
Johnny-come-lately stocks (annual sales for Riverbed didn't even
crack $100 million until 2007). Indeed, this stock has risen so
fast that it has become disconnected from the fundamentals. So you
may want to steer clear, regardless of the S&P 500 prospects.
And you can forget about industrial adhesives firm
Nordson (Nasdaq: NDSN)
, which only trades 178,000 shares a day.Index funds would trample
over each other trying to get into this stock, sharply inflating
its value -- and S&P likes to avoid that. The sub $500-million
revenue bases for
Highwoods Properties (
Salix Pharma (Nasdaq: SLXP)
are likely too small to warrant inclusion, as well.
If S&P is looking for high-tech exposure (which will likely be
the case in light of all the deal-making taking place in
Parametric Technology (Nasdaq: PMTC)
is the logical choice. Parametric's software helps companies extend
the life cycle of existing products through engineering design
tweaks, which has enabled the Parametric to develop robust streams
of recurring revenue. Of importance to S&P, Parametric is
consistently profitable and has seen annual sales fall only once in
the past six years.
Action to Take -->
In all likelihood, former S&P 500 member Warnaco is likely the
best fit for the
. Annual sales of $2 billion and $200 million in annual EBITDA is
nothing to sneeze at, and that brush with bankruptcy is a thing of
the past. Nowadays, analysts see a phoenix-like rise and have
recently boosted forecasts. Shares trade for a reasonable 13 times
projected 2011 profits, and a set of new product lines is expected
to help keep sales growing at a +10% pace. Along with Parametric
Technology, Warnaco looks set to get a tap on the shoulder from the
S&P advisory board. You may want to get in ahead of time.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.