Small-cap stocks can be incredibly lucrative investments because their lack of analyst coverage leads to frequent mispricings. However, these businesses (and their stock prices) often stay small because their subscale operations make it harder to expand their competitive moats.
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. That said, here are three small-cap stocks to avoid and some other investments you should consider instead.
Semtech (SMTC)
Market Cap: $9.78 billion
A public company since the late 1960s, Semtech (NASDAQ:SMTC) is a provider of analog and mixed-signal semiconductors used for Internet of Things systems and cloud connectivity.
Why Should You Dump SMTC?
- Costs have risen faster than its revenue over the last five years, causing its operating margin to decline by 16.5 percentage points
- Capital intensity has ramped up over the last five years as its free cash flow margin decreased by 7.6 percentage points
- Push for growth has led to negative returns on capital, signaling value destruction, and its shrinking returns suggest its past profit sources are losing steam
Semtech is trading at $102.44 per share, or 44.5x forward P/E. If you’re considering SMTC for your portfolio, see our FREE research report to learn more.
KB Home (KBH)
Market Cap: $3.32 billion
The first homebuilder to be listed on the NYSE, KB Home (NYSE:KBH) is a homebuilding company targeting the first-time home buyer and move-up buyer markets.
Why Are We Out on KBH?
- Demand cratered as it couldn’t win new orders over the past two years, leading to an average 28% decline in its backlog
- Earnings per share have dipped by 13.4% annually over the past two years, which is concerning because stock prices follow EPS over the long term
- Diminishing returns on capital suggest its earlier profit pools are drying up
At $52.95 per share, KB Home trades at 15.4x forward P/E. Read our free research report to see why you should think twice about including KBH in your portfolio.
Fortrea (FTRE)
Market Cap: $1.08 billion
Spun off from Labcorp in 2023 to focus exclusively on clinical research services, Fortrea (NASDAQ:FTRE) is a contract research organization that helps pharmaceutical, biotech, and medical device companies develop and bring their products to market through clinical trials and support services.
Why Should You Sell FTRE?
- Sales tumbled by 2.9% annually over the last four years, showing market trends are working against its favor during this cycle
- Negative returns on capital show that some of its growth strategies have backfired, and its falling returns suggest its earlier profit pools are drying up
- Waning returns on capital from an already weak starting point displays the inefficacy of management’s past and current investment decisions
Fortrea’s stock price of $11.31 implies a valuation ratio of 14.9x forward P/E. To fully understand why you should be careful with FTRE, check out our full research report (it’s free).
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