Stock picks to buy, cheap small

Over the last couple of months, stocks that are small, cheap, and deliver weaker returns on capital have turned into a freight train. It's incredibly powerful even if it can't keep going forever.

'This reminds us of the first two months of 2000,' wrote Jefferies SMID cap strategist Steven DeSanctis. He zeroed in on the performance of companies with low returns on equity, saying that, 'From the market low, the lowest ROE stocks have popped 220% vs. 129% for the highest ROE names, creating the biggest gap ever.'

He adds that lower returners have done even better in the last few months than they did in early 2000, near the market's peak during the tech bubble — and because there are more money-losing companies in the Russell 2000 index today than there were back then, valuations are even more extreme than they were in 2000.

Those kinds of comparisons frighten some investors, but DeSanctis says the news isn't all bad. For one thing, in 2020-21, the market's gains have been very broad instead of being concentrated in just a few stocks.

'We see over 1000 stocks have contributed to performance, while in '00 it was 92,' he said.

DeSanctis acknowledges that he's surprised that the recent increase in bond yields hasn't slowed small caps and low returners, but as the bear market fades from view, he says companies that deliver stronger returns on the money they invest in their businesses will predominate. A key ingredient is their improving earnings.

'If we see a pullback in the high-yield market and spreads starting to widen, or at least stop going down, that could change the dynamic,' he said. 'When GDP picks up, we do tend to find higher ROE beat lower ROE.'

In a market that is expected to be a strong one for stock pickers, DeSanctis says he looked for companies that will benefit from those trends.

The following 14 companies all have 'Buy' ratings from Jefferies, and they have improved the health of their balance sheets in the last year, haven't recently cut their forecasts, and are cheap based on their future price-to-earnings ratios.

The companies are ranked from highest to lowest based on their price to earnings ratios for the next fiscal year, as a lower ratio means investors pay less for the companies' expected future earnings. Those figures were calculated based on Friday's closing prices.