4 Small Cap Stocks That Top Mutual Funds Favor

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Small-cap stocks are in the doghouse of the stock market these days . The iShares Russell 2000Index ( IWM ) has lagged the S&P 500 for three straight quarters.

The market tilt toward large caps has brought small-cap valuations down -- although not to compelling levels, says Dave Wagner, who took over the $10.1 billion T. Rowe Price Small-Cap Value Fund on June 30.

But Wagner and other managers of top-performing mutual funds , which can benefit from encouraging inflow, say that they still see small-cap stock investment ideas.


Over long periods, small caps tend to outperform large caps. They're likelier to produce growth-driving innovations, Wagner notes. And they're likelier to be takeover targets.

"In a slow-growth environment like we have now, large caps can find growth through acquisitions of small companies," said Craig Hodges, lead manager of $1.5 billion Hodges Small Cap Fund .

Also, small caps tend to get far less revenue and earnings from activities abroad. "So they're less susceptible to world events like we're seeing now," Hodges said.

Even when small caps in general are out of favor, "there are attractive individual opportunities," Hodges added.

Hodges likes all three ofEagle Materials ' ( EXP ) business lines, including its newest, the fast-growing area of producing specialty sand used in fracking. The company owns a mine in Illinois where appropriate sand is near the earth's surface and near a river, where it can be loaded onto barges for transport to key oil and gas fields such as the Eagle Ford Shale and Permian Basin in and near Texas.

"And their cement and wallboard operations are more profitable than in the last economic cycle," Hodges said.

Forging Ahead

A key reason why Hodges likesUnited States Steel ( X ) is the consolidation in its industry.

"There are far fewer players, and it is extremely hard to get into this business," he said.

Surviving companies, like U.S. Steel, that can expand and add capacity are doing well, he adds.

U.S. GDP growth and rising car sales in particular benefit U.S. Steel. Hodges sees the company going from a $1.11 a share loss last year to earning $1.70 this year and about $2.50 in 2015.

Wagner likesGenesee & Wyoming ( GWR ). Short-line railroads run generally peripheral routes as opposed to main routes run by major big railroads likeUnion Pacific ( UNP ).

"Genesee is a blue chip in its space," Wagner said. "They are leaders in safety and efficiency."

The firm operates in North America and Australia. Wagner lauds its capital allocations and shareholder orientation. And there are huge barriers to entry by rivals.

Because many investors think of railroads as low-growth, there is little coverage. "That creates volatility opportunities," Wagner said.

He likesLandstar System (LSTR), a networking service that provides shippers with trucking by independent operators. Landstar lets truckers control their schedules while giving them access to regulatory compliance service and record-keeping, as well as to lower-cost fuel, insurance, parts and repairs. In return, Landstar avoids the costs of owning trucks.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.




This article appears in: Investing , Mutual Funds

Referenced Stocks: IWM , EXP , X , GWR , UNP

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