Small-cap stocks are taking the COVID-19 crisis harder than the big boys. The Schwab Fundamental U.S. Small Company Index exchange-traded fund is trading 16% lower in 2020 while the broader S&P 500 index gained 2% over the same period. On the upside, these drops can set investors up for strong returns if and when these stocks make a full recovery.
Here are three small-cap stocks that haven't exactly crushed the market in 2020, even though their long-term business prospects look strong. Locking in these little-known winners at today's low share prices will pay off through impressive returns for years to come.
Targeted ad campaigns
Shares of online ad-targeting specialist Criteo (CRTO -0.28%) are trading 25% lower year to date. The company obliterated Wall Street's earnings and revenue estimates in the second quarter but the stock barely moved on that news.
In all fairness, Criteo's sales fell 17% year over year while adjusted earnings came in 43% below the year-ago period's result. But both the company's management and Wall Street's analysts had been expecting even worse declines. Criteo is navigating the same uncertain COVID-19 waters as everybody else, but some of the surprises it found along the way have been positive.
"As the economic aftermath of the pandemic progressively unfolds, we believe direct response and targeted marketing remain key to help all clients weather the pandemic and accelerate their recovery," CEO Megan Clarksen said on the earnings call. "Our omnichannel business, helping clients target and engage their off-line or in-store customers online, grew more than 120%. We expect this to continue to grow nicely even after we get out of the pandemic."
In other words, Criteo is helping traditional retailers get their e-commerce operations off the ground with the help of effective digital marketing campaigns. That's a solid strategy that should pay dividends in the long run. Criteo's stock looks severely undervalued, trading at 8.7 times forward earnings estimates and 3.7 times free cash flows.
Smart speaker maker Sonos (SONO 0.45%) is trading 11% below its 52-week highs today, having gained 2% in 2020 so far. The stock has been incredibly volatile in the COVID-19 era, falling from $16 per share at the start of the year to less than $7 per share in March.
One might expect a digital media specialist like Sonos to do all right during lockdown periods, where consumers are stuck at home and hungry for digital entertainment options of every type. The second-quarter report didn't impress anybody, showing a 17% year-over-year revenue drop and deeper bottom-line losses. However, Sonos focuses on hardware more than software and services, which made the company vulnerable to distribution problems when electronics retailers largely closed their doors in March. Furthermore, the COVID-19 pandemic disrupted the restocking of Sonos products after a successful holiday quarter, leaving the shelves relatively bare in warehouses and the remaining retail stores.
But those are short-term issues that mask Sonos' positive long-term business trends. The pandemic gave Sonos an immediate boost in user engagement. Listening hours rose 48% year over year in April and should remain high in the upcoming third-quarter report. This crisis has exposed millions of potential users to entertainment options that they might not have considered in 2019, or that they already owned but largely forgot about. Some of these new or refreshed Sonos users will stick around for the long haul, adding devices and upgrading older speakers over time.
So the spring of 2020 was unpleasant but Sonos is positioned for long-term revenue growth in double-digit percentages. The company's direct-to-consumer (DTC) sales are replacing the weakened retail channel right now, and that strategy shift may also have long-lasting legs.
"I'm glad we invested a lot in terms of building that out over the last couple of years and making sure that we could address a spike in DTC demand. I mean, who could have imagined it would be a 400% spike, but you know that we could do this. And so we're going to continue to do that," said CEO Patrick Spence in May's second-quarter earnings call.
Kimball International (KBAL) crashed hard when office workers around the globe started working from home, and the stock has not staged much of a comeback from the yearly lows in March. At first glance, the maker of furniture for offices, hospitals, schools, and hotels appears to have picked some of the worst possible target markets for times like these. Schools and hotels aren't exactly clamoring for new furniture right now but the healthcare sector is picking up the slack. In early May, 95% of Kimball's manufacturing facilities were up and running, albeit at reduced production capacities.
So the company is learning some cost-saving tricks during the coronavirus crisis, and these new habits will help Kimball grow faster when the business world gets back to relatively normal operations again.
"We are confident that once a recovery sets in, our Company has the structure in place to achieve consistent mid-single-digit revenue growth and grow adjusted [earnings before interest, taxes, depreciation, and amortization] and EPS at a faster rate than sales," CFO Kristine Juster said on the third-quarter earnings call in May. "Looking to the medium- and long-term, we believe that this health crisis will cause many changes in the workplace environment that will provide additional opportunities for Kimball International to gain market share, leveraging our investments in innovation, flexible manufacturing and rapid time to market."
Kimball flies under Wall Street's radar with a market cap just north of $400 million. I can't find a single analyst who provides earnings estimates for this company's quarterly reports, even though the company has been crushing both the general market and archrival Steelcase (SCS -0.56%) in recent years. Here's how this stock stacked up against Steelcase and the S&P 500 in the five-year period between the start of 2015 and the end of 2019:
You should also know that Kimball's balance sheet is debt-free and its free cash flows were positive in the third quarter. This company will thrive again when things get back to normal, triggering a strong rebound in its share prices -- and most people won't even notice that they're missing out on those gains.