These tiny companies are making big money

Matt Krantz, USA TODAY9:02 a.m. EDT August 31, 2016

(Photo: KAREN BLEIER, AFP/Getty Images)

Want to live large off this stock market? Own small stocks.

Gains in shares of small companies are blowing away large-company indexes by a nearly 2-to-1 margin over the past three months. A dozen relatively obscure companies in the S&P SmallCap 600 index, including pawn and consumer loan

firmEzcorp (EZPW), materials company Chemours(CC) and a host of small energy companies likePioneer Energy (PES), have seen their shares rally more than 150% since small cap stocks bottomed this year on June 11, according to data from S&P Global Market Intelligence. Small cap stocks have been picking up the market's leadership ever since.

The S&P SmallCap 600 index is up 29% from its low this year in February, and during that time the large-cap heavy Standard & Poor's 500 index is up 19%.

The  "great rotation" taking place between small and large companies is turning into a big theme for the market, says Sam Stovall, U.S equity strategist at S&P Global Market Intelligence. Some small companies are expected to post some blistering profit growth, which is one of the drivers of the stocks. Analysts foresee earnings posted by companies in the S&P SmallCap 600 jumping 35% next year, which makes the S&P 500 look like it's standing still with an expected 14% rise in earnings growth.

Austin, Tex.-based Ezcorp, which operates pawning and lending facilities in 834 locations, highlights the trend. Shares of the company are up 313% to $10.28 apiece since the SmallCap 600 bottomed this year. Investors are trying to get in ahead of what's seen as being a solid year in calendar 2017, when adjusted profit is expected to rise 109%. That's coming off a solid calendar 2016, during which the company is expected to earn 29 cents a share and reverse a year-ago loss of 81 cents a share.

Small-cap companies are also giving investors ways to concentrate their bets. Profits from large companies in the materials sector are expected to boom 16% next year, the biggest source of profit growth in a sector after energy. But some smaller companies can do even better. Chemours, which sells industrial chemicals like titanium dioxide for brightening industrial coatings, is expected to put up 14% adjusted profit growth in 2017 and another 41% growth in 2017. Investors are getting in ahead of the gains, pushing the stock up 246% from the small-cap bottom to $13.38.

Energy stocks, though, are the biggest winners in small-cap land. Half of the 12 energy stocks that have jumped 150% or more from the February small-cap bottom are in the energy sector. Pioneer Energy, an oil and gas driller in San Antonio, has seen its stock jump 221% from February to $3.47 and analysts are calling for 55% adjusted earnings growth this year.

There's always a danger small-cap stocks are getting too big for investors' good. Both Ezcorp and Chemours, for instance, have already blown past analysts' average 18-month price targets. And the price-to-earnings ratio on the S&P SmallCap 600's trailing operating earnings is already nearly 68.

"We continue to see elevated risk of a market correction in the coming months, which we would expect to disproportionately impact small caps," according to a report fromBank of America Merrill Lynch released in mid-August and co-authored by quantitative analyst Dan Suzuki. "Elevated valuations, high expectations for growth (and stimulus), an increase in bullish positioning and volatility near post-crisis lows point to a complacent market ripe for disappointment."