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July 19, 2018, 7:50 a.m. EDT

These two trends will continue to power small-cap stocks

Jamie Cuellar of Kornitzer Capital Management says software as a service and 5G will buoy small-caps

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By Philip van Doorn, MarketWatch


Bloomberg
Shares of Twilio are attractively priced, according to Jamie Cuellar, manager of the Buffalo Small-Cap Fund.

It’s fair to wonder how much more outperformance we can expect from small-cap stocks, considering how well they have been performing in 2018. But there are always areas of innovation and demand that can make you money. Jamie Cuellar, the manager of the Buffalo Small-Cap Fund, discussed two trends and three companies poised to take advantage of them.

First, here’s a comparison of the 2018 performance of the Russell 2000 Index /zigman2/quotes/210598147/delayed RUT -0.33% , the S&P Small-Cap 600 /zigman2/quotes/210599868/delayed SML -0.44%  and the large-cap S&P 500 /zigman2/quotes/210599714/realtime SPX -0.02% :


FactSet

Both small-cap indexes have more than doubled the performance of the S&P 500 this year. So what does this mean? It certainly means an endless array of sensational headlines, some of which warn that the fast ride for small-cap stocks cannot last, in part, because domestic small-cap companies are expected to see larger benefits this year from the federal tax cut and rising dollar than larger companies.

But for long-term investors it may not be such a surprise to see small-caps outperforming. Here’s the same chart, but for 10 years:


FactSet

That’s an impressive track record, showing how important it is to have exposure to small-cap stocks, as well as the large-caps that dominate the headlines.

Read: You can make more money on small-cap stocks by playing this overlooked index

Two trends

Kornitzer Capital Management of Mission, Kansas, manages about $7 billion in client assets and is the subadviser for Buffalo Funds. Cuellar has managed the Buffalo Small-Cap Fund /zigman2/quotes/206708770/realtime BUFSX +1.86%  since January 2015.

Cuellar’s style is to identify companies with potential for “good revenue growth, with good pricing power and margins” for investments of three to five years. In an interview on July 13, he said the fund’s typical annual turnover of about 40% is low compared with a typical 100% turnover for actively managed small-cap funds.


Kornitzer Capital Management
Jamie Cuellar, manager of the Buffalo Small Cap Fund.

The two trends he focused on during the interview were increasing demand for SaaS computing (software as a service) and communications bandwidth.

The SaaS trend has been important for large-cap companies, including Microsoft /zigman2/quotes/207732364/composite MSFT +0.12% , with its cloud services and the migration of Microsoft Office to a subscription model. Other prime examples in the large-cap world include Salesforce.com /zigman2/quotes/200515854/composite CRM +0.29% and Workday /zigman2/quotes/201157610/composite WDAY -0.48%

The long-term SaaS trend has lowered risk for many software companies because under the old licensing model, “if you missed a sale, it had a devastating effect on the business model,” Cuellar said.

With this year’s strong performance, he said he had trimmed many positions in software companies, but here are two stocks of SaaS companies he believes are still trading at attractive valuations:

/zigman2/quotes/210598147/delayed
US : US Composite
1,506.98
-4.92 -0.33%
Volume: 326,678
Oct. 14, 2019 11:52a
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/zigman2/quotes/210599868/delayed
US : S&P US
931.47
-4.13 -0.44%
Volume: 140.62M
Oct. 14, 2019 11:57a
loading...
/zigman2/quotes/210599714/realtime
US : S&P US
2,969.72
-0.55 -0.02%
Volume: 480.24M
Oct. 14, 2019 12:07p
loading...
/zigman2/quotes/206708770/realtime
US : U.S.: Nasdaq
$ 13.12
+0.24 +1.86%
Volume: 0.00
Oct. 11, 2019
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/zigman2/quotes/207732364/composite
US : U.S.: Nasdaq
$ 139.85
+0.17 +0.12%
Volume: 5.24M
Oct. 14, 2019 12:07p
P/E Ratio
27.59
Dividend Yield
1.46%
Market Cap
$1066.51 billion
Rev. per Employee
$902,473
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/zigman2/quotes/200515854/composite
US : U.S.: NYSE
$ 149.80
+0.43 +0.29%
Volume: 561,805
Oct. 14, 2019 12:07p
P/E Ratio
124.58
Dividend Yield
N/A
Market Cap
$116.34 billion
Rev. per Employee
$379,486
loading...
/zigman2/quotes/201157610/composite
US : U.S.: Nasdaq
$ 179.57
-0.87 -0.48%
Volume: 292,224
Oct. 14, 2019 12:07p
P/E Ratio
N/A
Dividend Yield
N/A
Market Cap
$41.14 billion
Rev. per Employee
$269,447
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