Why now is the time for small-cap growth stocks (and 7 ripe for foraging)

You don't have to wait for the entire market to bottom to take advantage of the opportunities within global small-cap growth stocks, Forager's Steve Johnson said during a webinar on Wednesday. 

In fact, with some of these stocks down 50% to even 70%, many global small-caps are now looking ripe for the taking, he added. 

Since the beginning of the year, the MSCI World Index has fallen around 4.59%, while the tech-heavy NASDAQ Composite has dropped 9.39% as investors rush to sell out of their tech positions in anticipation of the US Federal Reserve raising rates. 

This has seen Forager's International Shares Fund fall around 12% in the six months to the end of December, and another 8% in January - taking the total return of the fund "from peak to trough to about -20%," Johnson said. 

"Under the surface, the individual stock movements have been far more significant than that," he said. 

"We got an email last week from JP Morgan, taking a look at the Russell 2000 Index of small-cap stocks in the US. That was also down about 20% from peak to current, but the average stock performance in that index is -39% from peak to current price as of the 25th of January, and we have seen a little bit of a bounce since then. 

"We've seen that in our own portfolio. There are significant moves in a number of stocks where they are down around 50-60% and even more per cent." 

Source: Forager

But this sell-off in the market has created exciting opportunities in terms of stock prices, Johnson said. 

In this wire, I'll summarise some of the key points from the boutique investment manager's latest webinar, and highlight some of the key stocks on their watchlist that they believe are currently ripe for foraging. 

Pivoting the portfolio towards traditional, Value stocks

Portfolio manager Gareth Brown said the team had recently pivoted the portfolio towards "larger-cap, more resilient businesses", with plenty of these stocks now sitting at the top end of the portfolio's holdings. 

This includes a recent purchase by the Fund, Tesco (LON: TSCO), he said. 

"Tesco is the largest grocery retailer in the UK. They've made some missteps in the past, with bad acquisitions and also just struggling to compete with discount grocers like Aldi and Lidl. But that's all changed," senior analyst Chloe Stokes said. 

"They've been continuously improving their market share, they're focused on the core business, and they have a great online offering that was made even more so throughout the pandemic."

The stock has returned around 28.29% over the past six months and is still attractively valued at around 13 times earnings, Stokes added.  

Why drawdowns should be seen as an opportunity

While Brown acknowledges that drawdowns "hurt", he notes that, generally speaking, falling share prices are "good" for long-term investors. 

"The lower your purchase price, the higher your future returns," he said. 

The fund currently has a 5% allocation to cash and can sell down its positions in companies like Facebook (NASDAQ: FB), Zebra Technologies (NASDAQ: ZBRA), and CDW (NASDAQ: CDW) to take advantage of "exceptional" opportunities. 

"This is why we get excited to come to work in times like this... These falls are getting more serious and we are starting to find quite interesting (opportunities)," Brown said.

Forager has split the opportunities that it is currently focused on into three categories, as seen below:

Source: Forager

The Fund recently acquired a new position in Celsius (NASDAQ: CELH), Brown revealed. This stock is currently trading around 54% lower than its peak in November 2021. 

"This is a very rapidly growing drinks business that we have made a genuine fortune out of over the last two years and we traded the ebbs and flows in share price particularly well," he said. 

"We like the economics there and we think the price makes sense again." 

Instead of reinvesting in gambling software provider GAN (NASDAQ: GAN), the team has opted for a "cleaner, pure, and safer play" in Flutter Entertainment (LON: FLTR), Brown said. 

In terms of the stocks the Fund already owns, the team is currently waiting to see if "a couple of things go right or the share price falls a bit further," Stokes said. 

The stocks the team is interested in, as seen in the image above, have already fallen significantly, with Ammo (NASDAQ: POWW), Tremor (LON: TRMR), Fathom (NASDAQ: FTHM) and NeoGames (NASDAQ: NGMS) suffering share price tumbles of 38.58%, 32.41%, 50.38% and 51.32% respectively over the last six months. 

"We think that the valuation makes some of the falls look quite excessive," Stokes said. 

Forager participated in the IPO of Fathom back in mid-2020 when the company was half the size it is today, Johnson added. 

"The share price went from US$10 at the IPO up to US$50, and then all the way back to US$12 in January this year. In the meantime, the revenue has more than doubled. The number of agents using its platform is up almost 100%. And they're guiding next year to some US$400 million of revenue relative to a current market capitalization of US$200 million," he said.

"This is still a young business, and there are still lots of potential futures to unfold, but it's less risky today than it was 12 months ago. And we are buying it at almost the same price."

Source: Bloomberg/Forager

Stocks on Forager's wishlist

Brown said the team always has a long list of ideas that the Fund would "enthusiastically own at the right price." Over the past month, the team has invested in several stocks that fit in that category and hopes to add more in the months ahead. 

"Flutter is a new position and it's one of our largest positions," Brown said. 

"This is an industry that we have known very well for years. We know the assets particularly well. The stock has been on our radar for years, it's the 40% pull-back in share price over the last few months of 2021 that really caught our attention." 

Flutter owns market-leading sports betting sites in Australia, the UK and the rapidly growing US market, he said. 

"I think the US market is the most interesting part of this business because it's where valuations could be wrong," Brown said. 

"We are very confident that Flutter will end up with a market-leading, or one of the market-leading positions in each of the states in which it operates and will probably be the largest player in most of the markets it operates. Which is a great place to start making money." 

Another example of a stock on Forager's wishlist is InMode (NASDAQ: INMD), which provides treatments for aesthetic conditions without patients needing to go under a scalpel.

"So think of someone who wants the results of plastic surgery, but without any of the incisions or the downtime," Stokes said. 

This is a really innovative business, she added. It has been growing its revenues significantly, and at high margins, and as an added bonus, InMode is "super-profitable". However, since its peak in November 2021, InMode's share price has fallen 50.51%. 

"So the valuation is starting to look attractive again at around 20 times earnings," Stokes said. 

"We are just taking baby steps into this position, it's quite small for us at the moment, but watch this space." 

"This rout could get worse" 

This is the pullback that you've been waiting for, Johnson said. However, "that is by no means a guarantee that we've seen the bottom - stock prices can fall further and harder than what we've seen so far, but it's a far more attractive entry point than it was six and seven months ago." 

"One conversation I've had with a few people recently is that these individual stocks can bottom out a long, long, long time before the overall market bottoms out," Johnson said. 

"I don't feel like this tech bubble is going to be properly burst until Tesla's half the price it is today rather than still trading at US$900 bucks." 

There still isn't widespread distress in the market, he noted, despite the 70-80% falls investors have seen in individual stocks. 

"Back in 2008-2009, my largest investment was the old RAMS home loans, RHG, and it hit its share price low 30 June 2008, which would've been a lot of tax-loss selling leading into the year," Johnson said. 

"But by the time the overall market had hit its bottom, which was March 2009 - so a full nine months after RHG had hit its lows, RHG was back up three and fourfold from its bottom.

"I think it is highly likely that you're going to see that (now)."

So investors need not wait for a market bottom to do well in the current investment environment, he said. 

"Drawdowns like we've seen over the past six and seven months are not just inevitable, they should be welcomed," Johnson said. 

This is investors chance to add "substantial amounts of value" over the longer term and create exceptional returns in the future, he added. 

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