Low-priced small-cap stocks may have the potential to pleasantly surprise investors who seek them out as alternatives to expensive growth stocks.
"I believe low valuations can be a good predictor of high returns in the future, which is why I'm more optimistic about owning small-cap stocks for the next 3 to 5 years than I've been in a decade," says Derek Janssen, portfolio manager of Fidelity® Small Cap-Discovery Fund (FSCRX).
Aside from low historical valuations, Janssen notes the valuation spread between growth and value stocks reached an all-time high early in 2020.
"And when valuation spreads are near all-time wides, I would rather take a chance on mean reversion than a further widening," he says.
The reason for this disparity, he says, is that very few investors feel small-cap value stocks are the place to be. This may make some people uncomfortable, but pessimism for the asset class is needed to create historically low prices, he says.
And Janssen took advantage of several bargains this spring to build sizable positions in companies he really liked. Among them was temp-staffing company ASGN (ASGN). He believed its variable cost structure would keep it solidly profitable in a recession, and that it had potential to be a much larger, more profitable company over time, given the growing demand for IT staffing.
Janssen notes he also purchased shares of trucking company TFI International (TFII) for the fund. He says the stock sold off with the rest of the market in March, but he considered TFI a quality operator with a strong management team.
He acknowledges that both stocks rebounded sharply in the second quarter.
"I continue to be on the lookout for value-priced small-caps my research suggests could benefit the fund in the coming years," Janssen says.
Fidelity® Small Cap Discovery Fund held securities mentioned in this article as of its most recent holdings disclosure.
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