Why Small-Cap Stocks ARRIS and Questcor Have Huge Growth Potential

See if either or both of these small-cap stocks belongs in your portfolio.

Jun 26, 2014 at 5:45PM

Source: ARRIS.

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 stocks to your portfolio but don't have the time or expertise to hand-pick a few, the Vanguard S&P Small-Cap 600 Index ETF (NYSEMKT:VIOO) could save you a lot of trouble. Instead of trying to figure out which stocks will perform best, you can use this exchange-traded fund to invest in lots of small-cap stocks simultaneously.

It's smart to include smaller companies in your portfolio, as the best of them can grow rapidly and eventually become large caps. Small-cap stocks have outperformed their larger brethren over some long stretches, though they can be a little more risky. Large-cap companies have proven themselves, to some degree, but they can't grow nearly as quickly as a small-cap might.

The ETF's basics
ETFs often sport lower expense ratios than their mutual fund cousins. The Vanguard S&P Small-Cap 600 Index ETF, focused on small-cap stocks, sports a tiny expense ratio -- an annual fee -- of 0.15%. This ETF is fairly small, so if you're thinking of buying, beware of possibly large spreads between its bid and ask prices. Consider using a limit order if you want to buy in.

On your own you might not have selected ARRIS Group (NASDAQ:ARRS) or Questcor Pharmaceuticals (NASDAQ:QCOR) as small-cap stocks for your portfolio, but this ETF includes them among its 600 holdings. The ETF has slightly lagged the S&P 500 over the past few years, but it's the long run that matters, and large-cap and small-cap stocks don't move in lockstep.

A closer look at ARRIS Group
ARRIS Group offers those who are still kids at heart to chuckle at its ticker symbol that suggests pirate talk. There's more to the company than that, of course. It acquired Motorola Home last year and is in the business of offering video and broadband technology to cable system operators -- think set-top boxes. The stock has more than doubled over the past year, and popped by more than 10% in May after the company posted strong first-quarter results that featured estimate-topping revenue and earnings, its order backlog nearly doubling to $1 billion, and management significantly increasing its projections.

The fact that cable companies are competing aggressively with each other bodes well for ARRIS, as they can use new and fancier set-top boxes to differentiate themselves. ARRIS is also well positioned in the Internet Protocol TV (IPTV) arena, giving it another leg up. ARRIS took on a lot of debt in its Motorola Home acquisition, but it has already begun paying that down. It does face some deep-pocketed competition, but last quarter management suggested that ARRIS is spending more on R&D than competitors.

ARRIS is not without risk, but with its relatively low forward P/E ratio of about 12  and ample free cash flow, it's an intriguing candidate for a portfolio. A handful of Wall Street analysts have recently raised their price targets and/or upped their ratings for the stock.

A closer look at Questcor Pharmaceuticals
One of the most important things to know about Questcor is that it's being bought out by Mallinckrodt (NYSE:MNK) for $5.6 billion. Questcor is largely known for its multiple-sclerosis drug Acthar, which has been approved for 19 indications. That has made some nervous, with so many eggs in that one Acthar basket. On top of that, the company is being investigated for how it has marketed Acthar.

The company is expanding its product lineup, though, having recently bought the rights to two drugs that address multiple indications that include certain autoimmune and inflammatory conditions. The rights apply in certain countries outside the U.S., and they were bought from Novartis Pharma AG and Novartis AG. Questcor will pursue approval in the U.S., too.

Meanwhile, though, some are wondering whether the deal with Mallinckrodt will fall through, as it's reported that the merger proxy documents don't sufficiently address Questcor's risks and that Cigna has cast doubt on the value of Acthar, relative to alternatives. There's clearly growth potential in Questcor, but if you're thinking of investing in it, you might want to wait for some dust to settle, or the investigations into it to end.

The big picture
It makes sense to include some small-cap stocks in your portfolio. You can do so easily via an ETF. Alternatively, you might simply investigate an ETF focused on small-cap stocks and then cherry-pick from its holdings after doing some research on your own.

Here's another small-cap stock with great potential
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns shares of Google (C shares) and Novartis. The Motley Fool recommends Cisco Systems, Google (A shares), and Google (C shares). The Motley Fool owns shares of Google (A shares) and Google (C shares). 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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