By Philip van Doorn, MarketWatch
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 -1.22% , the S&P Small-Cap 600 /zigman2/quotes/210599868/delayed SML -1.26% and the large-cap S&P 500 /zigman2/quotes/210599714/realtime SPX -0.38% :
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:
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.
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 -1.41% 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
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 +1.25% , 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 -1.32% and Workday /zigman2/quotes/201157610/composite WDAY -0.06% .
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: