Small-Cap Growth Stocks: A Long-Term Winning Investment

This investment focused on small-cap growth stocks has trounced the S&P 500 over time.

Jan 16, 2014 at 5:15PM

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some small-cap growth stocks to your portfolio but don't have the time or expertise to hand-pick a few, the SPDR S&P 600 Small Cap Growth ETF (NYSEMKT:SLYG) could save you a lot of trouble. Instead of trying to figure out which companies will perform best, you can use this ETF to invest in lots of them simultaneously.

The basics
ETFs often sport lower expense ratios than their mutual-fund cousins. This ETF, focused on small-cap growth stocks, sports a relatively low expense ratio -- an annual fee -- of 0.28%.

This ETF has handily outperformed the S&P 500 over the past three, five, and 10 years. As with most investments, of course, we can't expect outstanding performances in every quarter or year. Investors with conviction need to wait for their holdings to deliver.

Why small-cap growth stocks?
It's smart to include smaller companies in your portfolio, as the best of them can grow rapidly and eventually become large caps. It's appealing to add some "growth" stocks to your portfolio, too, in the hope of juicing its overall performance. Many small-cap growth stocks offer significant growth potential, and plenty of them are undervalued, too.

More than a handful of small-cap growth stocks had strong performances over the past year. Align Technology (NASDAQ:ALGN) soared 139%, for example. Align Technology is a teeth-straightening specialist, known for its Invisalign aligner, as well as some CAD/CAM software. Its last quarterly report sent shares soaring 26% on news of revenue growing 21% over year-ago levels, along with management's rosy outlook. Sales are growing particularly briskly abroad, and the company has been buying back stock. It's hard to see Align Technology stock as a bargain now, though, with its P/E ratio topping 150.

Questcor Pharmaceuticals (NASDAQ:QCOR) popped 122%, and to some investors it does seem like quite a bargain. Questcor is largely known for its multiple-sclerosis (MS) drug Acthar. Questcor has fat profit margins and substantial and growing free cash flow, and with a forward P/E ratio near 10, it's attractively priced -- especially given its solid growth rate. Critics haven't liked Questcor's pricing practices and it has been under a cloud of investigations for some time now, but the investigations haven't seemed very fruitful, and they've already knocked some value off the stock. Still, it's not unreasonable to hold off on companies under investigation. Questcor Pharmaceuticals stock yields 2.3%, and its dividend was hiked by 25% last year and 20% this year.

ViroPharma (NASDAQ:VPHM) surged 93% over the past year. Initially, that was in large part due to speculation that the maker of drugs for rare diseases would be bought out at a premium -- but then the company actually was acquired by Shire. Some worry about risks tied to ViroPharma's key product, Cinryze, which treats the rare condition of hereditary angioedema, while Shire expects Cinryze sales to account for 40% of its revenue. But overall, the acquisition reflects how attractive orphan drugs can be, and it's fueling speculation about other possible buyouts.

Texas Capital Bancshares (NASDAQ:TCBI) gained a solid 36%, and is near a 52-week high. Its third quarter featured expectation-missing earnings but also growing deposits and rising net interest margins. Analysts at Zacks Equity research have a neutral rating on Texas Capital Bancshares, liking its consistent loan and deposit growth but worrying about its rising expenses and provision for loan losses. With a forward P/E ratio near 16 and a current P/E near 22, above its five-year average of 20, the stock doesn't seem a screaming bargain.

Other small-cap growth stocks didn't do quite as well over the last year, but could see their fortunes change in the coming years. The ETF's impressive, market-beating 10-year average return of nearly 11% reflects some less-impressive performance from components -- otherwise the average annual gain might be closer to 50% or 100%.

The big picture
If you're interested in adding some small-cap growth stocks to your portfolio, consider doing so via an ETF. A well-chosen ETF can grant you instant diversification across any industry or group of companies -- and make investing in it and profiting from it that much easier.

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Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, owns shares of Questcor Pharmaceuticals. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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