Many small-cap stocks have limited Wall Street coverage, giving savvy investors the chance to act before everyone else catches on. But the flip side is that these businesses have increased downside risk because they lack the scale and staying power of their larger competitors.
The downside that can come from buying these securities is precisely why we started StockStory - to isolate the long-term winners from the losers so you can invest with confidence. Keeping that in mind, here are three small-cap stocks to avoid and some other investments you should consider instead.
The Toro Company (TTC)
Market Cap: $9.42 billion
Ceasing all production to support the war effort during World War II, Toro (NYSE: TTC) offers outdoor equipment for residential, commercial, and agricultural use.
Why Does TTC Give Us Pause?
- 2.7% annual revenue growth over the last two years was slower than its industrials peers
- Earnings per share lagged its peers over the last five years as they only grew by 4.5% annually
- Eroding returns on capital suggest its historical profit centers are aging
The Toro Company is trading at $98.89 per share, or 20.4x forward P/E. Read our free research report to see why you should think twice about including TTC in your portfolio.
LGI Homes (LGIH)
Market Cap: $1.43 billion
Based in Texas, LGI Homes (NASDAQ: LGIH) is a homebuilding company specializing in constructing affordable, entry-level single-family homes in desirable communities across the United States.
Why Is LGIH Risky?
- Customers postponed purchases of its products and services this cycle as its revenue declined by 10.4% annually over the last five years
- Waning returns on capital from an already weak starting point displays the inefficacy of management’s past and current investment decisions
- 21× net-debt-to-EBITDA ratio shows it’s overleveraged and increases the probability of shareholder dilution if things turn unexpectedly
At $61.48 per share, LGI Homes trades at 16.4x forward P/E. To fully understand why you should be careful with LGIH, check out our full research report (it’s free).
Merchants Bancorp (MBIN)
Market Cap: $2.55 billion
With a strategic focus on low-risk, government-backed lending programs, Merchants Bancorp (NASDAQCM:MBIN) is an Indiana-based bank holding company specializing in multi-family mortgage banking, mortgage warehousing, and traditional banking services.
Why Does MBIN Worry Us?
- Sales trends were unexciting over the last two years as its 5.6% annual growth was below the typical banking company
- Operational productivity has decreased over the last five years as its efficiency ratio worsened by 16.6 percentage points
- Insufficient tier one capital ratio of 9.4% leaves little margin for error in meeting regulatory liquidity requirements
Merchants Bancorp’s stock price of $55.62 implies a valuation ratio of 1.2x forward P/B. Check out our free in-depth research report to learn more about why MBIN doesn’t pass our bar.
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