Small-cap stocks in the Russell 2000 (^RUT) can be a goldmine for investors looking beyond the usual large-cap names. But with less stability and fewer resources than their bigger counterparts, these companies face steeper challenges in scaling their businesses.
The high-risk, high-reward nature of the Russell 2000 makes stock selection critical, and we’re here to guide you toward the right ones. That said, here are three Russell 2000 stocks to avoid and better alternatives to consider.
Sprout Social (SPT)
Market Cap: $358 million
Born from the recognition that businesses needed a centralized way to handle their growing social media presence, Sprout Social (NASDAQ: SPT) provides a comprehensive software platform that helps businesses manage, analyze, and optimize their presence across various social media networks.
Why Does SPT Give Us Pause?
- Average billings growth of 8.7% over the last year was subpar, suggesting it struggled to push its software and might have to lower prices to stimulate demand
- Estimated sales growth of 7.8% for the next 12 months implies demand will slow from its two-year trend
- Operating losses show it sacrificed profitability while scaling the business
At $5.87 per share, Sprout Social trades at 0.7x forward price-to-sales. Check out our free in-depth research report to learn more about why SPT doesn’t pass our bar.
Sally Beauty (SBH)
Market Cap: $1.45 billion
Catering to both everyday consumers as well as salon professionals, Sally Beauty (NYSE: SBH) is a retailer that sells salon-quality beauty products such as makeup and haircare products.
Why Do We Pass on SBH?
- Failure to add new stores points to soft demand and a focus on boosting sales at current locations
- Weak same-store sales trends over the past two years suggest there may be few opportunities in its core markets to open new locations
- Modest revenue base of $3.71 billion gives it less fixed cost leverage and fewer distribution channels than larger companies
Sally Beauty is trading at $14.95 per share, or 7x forward P/E. Dive into our free research report to see why there are better opportunities than SBH.
Ellington Financial (EFC)
Market Cap: $1.5 billion
Operating under the guidance of Ellington Management Group, a respected name in structured credit markets, Ellington Financial (NYSE: EFC) acquires and manages a diverse portfolio of mortgage-related, consumer-related, and other financial assets to generate returns for investors.
Why Do We Avoid EFC?
- Incremental sales over the last five years were less profitable as its 2.7% annual earnings per share growth lagged its revenue gains
- Products and services are facing significant credit quality challenges during this cycle as tangible book value per share has declined by 5.6% annually over the last five years
- Low return on equity reflects management’s struggle to allocate funds effectively
Ellington Financial’s stock price of $11.99 implies a valuation ratio of 0.9x forward P/B. If you’re considering EFC for your portfolio, see our FREE research report to learn more.
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