The optimism surrounding the first vaccine trial data caused a massive rotation in the markets… 

Billions of dollars flowed into cyclical stocks, especially small-caps. 

And over the past month, small-caps have been among the biggest winners…

The Russell 2000 small-cap index is up 9.9% since November 17, the day before Pfizer (PFE) and BioNTech (BNTX) announced their vaccine data. Meanwhile, the S&P 500 large-cap index is up just 2.7% during the same time period. 

Today, I’ll explain why small-caps are poised to see much higher gains in the current environment… and four small-caps stocks with particularly bright futures.

What is a small-cap stock?

Market capitalization, or market cap, measures a stock’s total market value. It’s calculated by multiplying a stock’s price by the total number of shares outstanding. Market cap is typically divided into three categories based on size: large-cap, mid-cap, and small-cap. A small-cap generally has a market cap of between $300 million to $2 billion. 

Small-cap stocks have historically outperformed large cap stocks. Over the past 20 years, the Russell 2000 has returned 325%. That’s far better than the S&P 500, which generated a 180% gain over the past 20 years. 

But here’s the catch—small cap stocks are riskier. This risk shows up as higher volatility compared to the rest of the stock market. During selloffs, small-cap companies typically see sharp declines. For instance, during the March selloff this year, the Russell 2000 fell a startling 41.6% from February 20 through March 18. In comparison, the S&P 500 lost 28.9% over the same period.

The main advantage of small-cap stocks over large-cap stocks is that small companies have more room for growth. There’s a simple reason for this. It’s much easier for a smaller company to double in size as its business expands. A successful new product can easily turn a $500 million company into a $1 billion company. By comparison, it’s tougher for a $100 billion company to become a $200 billion company. 

Why invest in small-caps now?

While small-cap stocks have historically performed better than large-caps, they have underperformed recently—especially during the pandemic. Since November 2013, the Russell 2000 is up 72%. That’s well below the S&P 500’s 105% gain during that time. Meanwhile, big tech stocks have thrived. Tech giants like Google and Amazon have business models well-suited to the “stay at home” economy. 

But, as I mentioned earlier, the COVID vaccine has revived small-caps. 

As a large percentage of the population gets vaccinated in 2021, the economy will rebound sharply. That should drive higher growth for small-cap companies… and their shares. And since the stock market is forward-looking, money is already flowing into small-cap stocks in anticipation. 

Wall Street analysts are also jumping on the trend by raising their earnings estimates for small-cap stocks. According to Yardeni Research, earnings for stocks in the S&P 600 (another small-cap index) are expected to increase 75% year-over-year in 2021. For comparison, earnings growth for the S&P 500 is expected to increase by just 22% next year. 

Put simply, analysts expect small-cap companies to grow their earnings three times (3x) more than companies in the S&P 500 next year!

How to profit off the rotation into small-caps

A well-diversified portfolio typically includes some exposure to small-cap stocks, especially for a more aggressive investor. But as small-cap stocks become the new market leaders, investors should consider increasing their allocation to smaller companies. Here are four companies with incredible potential as we head into 2021.

Winnebago Industries (WGO)

Winnebago Industries is a leading producer of recreational vehicles (RVs) in the U.S. Demand for RVs jumped during the pandemic, with families looking to vacation while minimizing COVID exposure. 

Winnebago’s fiscal fourth quarter results confirmed the growth trend. Revenue surged 39% vs. the same period last year, while earnings jumped 41%. The company noted strong sales in both its Towable and Motorhome segments.

Another bullish sign comes from Winnebago’s record-breaking backlog—orders for vehicles yet to be delivered. The company’s towable RVs segment looks especially promising. Towable RVs have a higher margin, which means they generate bigger profit for Winnebago. This segment accounted for 88% of the company’s adjusted EBITDA last year.

Winnebago posted strong quarterly results on Friday, December 18. Earnings outperformed estimates and were up 41% year over year. Management is seeing strong momentum across all segments as the company gains more market share.

Cooper Tire & Rubber (CTB)

Cooper Tire & Rubber Co is a manufacturer of replacement tires for cars, trucks, and motorcycles. The pandemic boosted demand for used cars, as automakers shuttered their production lines and people avoided public transportation. 

Cooper Tire should benefit from continued demand for used cars—which translates into strong demand for tires. As the pandemic starts to fade, I doubt most folks will rush back to public transportation, maintaining used car demand. 

This trend is already driving Cooper Tire’s results. The company had a very strong third quarter, with earnings soaring 317% year-over-year. Analysts expect Cooper Tire to grow earnings by 296% next quarter, and 25% next year. The company also has a strong balance sheet, which allows it to pay a 1% dividend yield. Not bad for a small company!

Hibbett Sports, Inc. (HIBB)

Hibbett Sports is an athletic retailer that operates in the South, Southwest, Mid-Atlantic, and Midwest regions of the U.S. The company focuses on areas with smaller populations. While some retailers struggled during the pandemic, Hibbett Sports has prospered.

Hibbett is benefiting from a surge in demand for sporting goods and athletic casual wear. People haven’t been able to go on cruises or attend live events due to COVID. They’re spending their money on other stuff… and retailers like Hibbett are benefiting. 

Hibbett’s latest results show a huge jump in online sales, which grew 51% vs. the same period last year. The company launched its e-commerce website in 2018, giving customers the ability to place their orders online during the recent lockdowns. 

Hibbett’s in-store sales are also growing—up 17.5% during the most recent quarter. Management also provided upbeat guidance for 2021, announcing a loyalty program and in-store improvements to retain its new customers. 

American Axle & Manufacturing Holdings, Inc. (AXL)

Our last small-cap stock is American Axle & Manufacturing Holdings. It’s a supplier of driveline and drivetrain systems, modules, and components for the light vehicle market. This market covers vehicles with a capacity of 1 ton or less, which includes most passenger and sports cars. One of Wall Street’s biggest stories this year was the rise of electric vehicles such as Tesla. American Axle will be a part of that future since it develops parts for electric vehicles, including electric drive systems and powertrain components.

The company recently won a 2020 automotive PACE award in innovation for its new electric driveline solution. American Axle was able to create a high-performance electric driveline in a compact package, which set new standards for power and torque density. This has led to new business for the company, with automotive manufacturers always looking for the latest technology.

It’s also worth mentioning the stock is super-cheap. Shares of American Axle & Manufacturing trade at a forward P/E of 6.24. That’s a bargain considering the company’s growth opportunities in the electric vehicle space.

Taking action

If you’re looking to increase your exposure to small-caps, these four stocks can supercharge your portfolio into the new year.

With the rollout of COVID vaccines in early 2021, we’re likely heading for a return to normal. And a rebounding economy will create the perfect setup for small-caps to soar.

Authors that regularly contribute articles covering topics in their area of expertise.