These Investments Rise When Small Caps Fall

Despite stock market gains in recent days, investors of all shapes and sizes are still spooked. This is especially the case for small-cap investors that have seen stocks wipe out big gains garnered earlier this year. After performing some broad-based due diligence, we have uncovered some interesting historical occurrences following small-cap selloffs. In many cases, the selloffs are directly followed by gains in bonds and small-cap value stocks and I believe this phenomenon is poised to repeat itself.

For example, the last time that U.S. small-cap stocks outperformed all other asset classes was in 2010. The following year, bonds, including 20-Year U.S. Government Bonds and U.S. TIPS outperformed all asset classes.  In 2013, small-cap stocks were the clear asset class winner so it stands to reason that these bonds may be the best-performing asset class in 2014.  Interestingly, we proffer that with a low interest rate environment and few real options for one’s money, ETFs mirroring the high yield bond sector, which is essentially the corporate bonds’ version of small-cap stocks, might be an even better option in the near term.  This is especially the case considering we are in the early stages of an improving economy.

For equity-only or equities-focused investors, rotations from growth into value almost always transpire just after growth stocks drop due in large part to unsustainable valuations in growth sectors, as is this case today. There are a number of interesting options, but I believe that as we enter the spring season, Primo Water Corp. (NASDAQ – PRMW - $3.97), a stock we profiled eight months ago that has risen by 50%, could come under serious accumulation in the near term.

Primo, named after is founder and CEO Billy Prim, provides multi-gallon purified bottled water, self-serve filtered drinking water, and water dispensers in the United States and Canada. The company operates through two segments: Primo Water and Primo Dispensers. The Primo Water segment offers multi-gallon purified bottled water or self-serve filtered drinking water vending service through retailers. The Primo Dispensers segment sells water dispensers that are designed to dispense Primo and other dispenser-compatible bottled water. The company’s products and services are offered at approximately 24,500 retail locations, including some Wal-Mart (NYSE – WMT) stores.

Primo had a strong 2013 financial performance with sales of $91.2 million and a jump in adjusted EBITDA of 66% to $9.1 million. For this year, management forecasts sales of $98 million to $102 million and adjusted EBITDA of $10.6 million to $11 million.  The projected increase in sales will be aided in part by a new agreement with DS Water of America, a leading home beverage delivery network, whereby Primo will take over all five-gallon exchange, account management and billing services.

At current levels, the stock trades around 1x revenue and 10x adjusted EBITDA. If additional margin expansion occurs, which we deem likely, the stock could reach $5 in the coming quarters.

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