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Small-Cap Stock Growth vs. Quality vs. Valuation -- Which Is Best?

5/25/2021

One of the hardest struggles of following a “growth at a reasonable price” (GARP) strategy is identifying good small company candidates during extended periods of high equity valuations.

With the S&P Small-Cap 600 Index up more than 20% year-to-date, many small company stocks are now beginning to reach valuation levels achieved by large-cap stocks in the last half of 2020.

Indeed, the S&P 500 Index is up just under 12% year-to-date for 2021 as there is just not that much remaining headroom for many market favorites to continue to make new highs until fundamentals have a chance to catch up.

Even though stocks are in a broad uptrend, there are always opportunities to be found. In this issue, 20 of the 47 companies we cover in the newsletter are currently below our suggested maximum buy price (including the two monthly recommendations). I covered this topic in the May issue of the SmallCap Informer when I reminded subscribers that a current holding that has performed may well still provide further upside.

If you are committed to adding new holdings to your portfolio instead of increasing positions of current stocks, it may be tempting during this period of market over-valuation to stray from your investing strategy—to overpay for a stock or to chase growth at any price or to compromise on quality standards. All three of these approaches could prove costly, and if utilized in any combination quite detrimental to your returns.

Our GARP approach allows leeway in our requirements in that we can focus more on growth criteria when the market is weak and on reasonable prices when the market is overextended. But we always hold the line when it comes to company quality, and this leg of our strategy provides support when the market reverses course. Over time, this attention to quality is a significant contributor to a favorable ratio of portfolio risk and return.

  • DOUG GERLACH

Reprinted from the June 2021 issue of the SmallCap Informer.

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