Small Cap Growth Style 4Q16: Best and Worst

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The Small Cap Growth style ranks eleventh out of the twelve fund styles as detailed in our 4Q16 Style Ratings for ETFs and Mutual Funds report. Last quarter, the Small Cap Growth style ranked eleventh as well. It gets our Dangerous rating, which is based on an aggregation of ratings of 12 ETFs and 383 mutual funds in the Small Cap Growth style as of November 8, 2016. See a recap of our 3Q16 Style Ratings here.

Figures 1 and 2 show the five best and worst rated ETFs and mutual funds in the style. Not all Small Cap Growth style ETFs and mutual funds are created the same. The number of holdings varies widely (from 22 to 1843). This variation creates drastically different investment implications and, therefore, ratings.

Investors seeking exposure to the Small Cap Growth style should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2.

Figure 1: ETFs with the Best & Worst Ratings – Top 5

NewConstructs_SmallCapGrowth_ETFAllocation* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5

NewConstructs_SmallCapGrowth4Q16_AllocationofMFs* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Walden SMID Cap Fund (WASMX) is excluded from Figure 2 because its total net assets (TNA) are below $100 million and do not meet our liquidity minimums.

SPDR S&P 600 Small Cap Growth ETF (SLYG) is the top-rated Small Cap Growth ETF and Virtus Small-Cap Core Fund (VSCRX) is the top-rated Small Cap Growth mutual fund. SLYG earns an Attractive rating and VSCRX earns a Very Attractive rating.

PowerShares Russell 2000 Pure Growth Portfolio (PXSG) is the worst rated Small Cap Growth ETF and PACE Small/Medium Growth Equity Investments (PQUAX) is the worst rated Small Cap Growth mutual fund. PXSG earns a Dangerous rating and PQUAX earns a Very Dangerous rating.

Skechers USA (SKX: $21/share) is one of our favorite stocks held by RFG and earns a Very Attractive rating. SKX was featured as a Long Idea in April 2016 and is on this month’s Most Attractive Stocks list. Over the past decade, Skechers has grown after-tax profit (NOPAT) by 19% compounded annually. The company has improved its return on invested capital (ROIC) from an already impressive 11% in 2005 to a top-quintile 17% over the last twelve months (TTM). Despite the long-term improvement in the business fundamentals, SKX remains significantly undervalued. At its current price of $21/share, SKX has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects SKX’s NOPAT to permanently decline by 10%. If SKX can grow NOPAT by just 8% compounded annually over the next decade, the stock is worth $34/share today –a 62% upside.

SPS Commerce (SPSC: $62/share) is one of our least favorite stocks held by PQUAX and earns a Very Dangerous rating. SPCS was also placed in the Danger Zone in August 2016. SPSC’s economic earnings have declined from $2 million in 2010 to -$5 million TTM. The company’s ROIC has fallen from an impressive 24% in 2010 to a bottom-quintile 4% TTM all while the company has burned through $81 million in free cash flow since 2011. Despite the business operations heading in the wrong direction, SPSC remains priced for significant profit growth. To justify its current price of $62/share, SPSC must grow NOPAT by 18% compounded annually for the next 24 years. These expectations seem awfully high for a business that is currently losing money.

Figures 3 and 4 show the rating landscape of all Small Cap Growth ETFs and mutual funds.

Figure 3: Separating the Best ETFs From the Worst Funds

NewConstructs_SmallCapGrowth_ETFLandscape

Sources: New Constructs, LLC and company filings

Figure 4: Separating the Best Mutual Funds From the Worst Funds

NewConstructs_SmallCapGrowth_MutualFundLandscape

Sources: New Constructs, LLC and company filings

This article originally published here on November 8, 2016.

Disclosure: David Trainer, Kyle Guske and Kyle Martone receive no compensation to write about any specific stock, style, or theme.

Click here to download a PDF of this report.

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