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800 Undervalued Small-Cap Stocks

By Selena Maranjian - Feb 5, 2014 at 6:15PM

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The best undervalued small-cap stocks have a lot of room to grow.

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some undervalued small-cap stocks to your portfolio but don't have the time or expertise to hand-pick a few, the Vanguard Small Cap Value ETF (VBR 0.81%) could save you a lot of trouble. Instead of trying to figure out which undervalued small-cap stocks will perform best, you can use this ETF to invest in about 800 of them simultaneously.

The basics
ETFs often sport lower expense ratios than their mutual-fund cousins. This ETF, focused on undervalued small-cap stocks, sports a very low expense ratio -- an annual fee -- of 0.1%. It recently yielded about 1.9%, too.

This undervalued-small-cap-stocks ETF has outperformed the S&P 500 over the past 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 undervalued small-cap 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 also smart to focus on undervalued stocks, as they offer margins of safety. Thus, undervalued small-cap stocks deserve strong consideration, whether you buy them in bulk via an ETF or whether you cherry-pick them. (Note that some of this ETF's components aren't that tiny.)

More than a handful of undervalued small-cap stocks had strong performances over the past year. The Goodyear Tire & Rubber Company (GT 2.80%) surged 69% and yields 0.8% via a newly reinstated dividend. It has faced some labor issues (including a brief hostage-taking last year) and recently resolved a long struggle with French labor unions. With a forward P/E ratio near 7, the stock seems a value. The company reports its fourth-quarter results on Feb. 13. Its third quarter was reasonably strong, thanks in part to a recovering industry. Its free cash flow has been in the red but is improving recently.

United Rentals (URI -0.40%) popped 48% and recently reported a strong quarter, with revenue up 7% over year-ago levels and adjusted earnings surging 25%. It's three times bigger than its nearest competitor and is spending aggressively on stock buybacks, which can help keep its growing share count in check. By buying RSC Rentals, United Rentals has been able to add higher-margin clients to its business.

GameStop (GME 8.57%) gained 31% and yields 3.1%. Some are bearish about it, seeing the growth of online gaming hurting a physical retailer like GameStop. (The new Apple TV, for example, will offer game-playing functionality.) Bulls, though, point to the new-console cycle, with new PlayStations and Xboxes ushering in a new wave of used games for the retailer to sell. They might concede that the long-term future is uncertain, but they like the company's near-term prospects.

Other undervalued small-cap stocks didn't do quite so well over the last year but could see their fortunes change in the coming years. AGL Resources (NYSE: GAS) advanced just 16% and yields a solid 4.2% thanks to a recent dividend increase. It has been racking up contracts such as an additional one with United Parcel Service to supply liquefied natural gas to the delivery giant's fleet. Situated in some regulation-friendly areas, it has been boosting its natural-gas-transmissions business. In its fourth quarter, rising operating costs depressed earnings, however.

The big picture
If you're interested in adding some undervalued small-cap 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 and profiting from it that much easier.

Selena Maranjian, whom you can follow on Twitter, owns shares of Apple. The Motley Fool recommends Apple and United Parcel Service. The Motley Fool owns shares of Apple and GameStop. 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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Stocks Mentioned

Vanguard Index Funds - Vanguard Small-Cap Value ETF Stock Quote
Vanguard Index Funds - Vanguard Small-Cap Value ETF
$164.78 (0.81%) $1.33
United Rentals, Inc. Stock Quote
United Rentals, Inc.
$322.14 (-0.40%) $-1.29
The Goodyear Tire & Rubber Company Stock Quote
The Goodyear Tire & Rubber Company
$13.60 (2.80%) $0.37
GameStop Corp. Stock Quote
GameStop Corp.
$43.45 (8.57%) $3.43

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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