Small-cap stocks have generated outstanding returns for an extended period, historically, when coming out of a compression point in the market, where it has been flat for a decade or longer, and higher returns are expected over the next couple of years as a result of the recent recession, says Douglas G. Pugh, CFA, Principal and Portfolio Manager of Peregrine Capital Management, Inc.
“We are currently seeing average stock valuations coincident with higher margins earlier in the cycle,” he said. “As a result, what we are seeing today are not peak gross margins. We expect to see higher margins throughout the course of this cycle, higher than we have seen in the past.”
Pugh likes Hanesbrands Inc. (HBI), a manufacturer of essential apparel, undergarments and some outergarments. He says HBI is trading at only 11 times 2012 earnings estimates, but there are a lot of catalysts in place for improved earnings and higher valuation. Mr Pugh also favors the company’s 14% free cash flow yield, despite its large amount of debt.
“They have a lot of debt on their balance sheet, about 73% debt to cap, but they are a huge cash-flow generator. Management expects to deploy that cash to pay down in the neighborhood of over $800 million in debt over the next year and a half. If they do that, they will save about $0.45 per share in interest costs,” he said.