The Russell 2000 (^RUT) is home to many small-cap stocks, offering investors the chance to uncover hidden gems before the broader market catches on. However, these companies often come with higher volatility and risk, as their smaller size makes them more vulnerable to economic downturns.
The high-risk, high-reward nature of the Russell 2000 makes stock selection critical, and we’re here to guide you toward the right ones. That said, here are three Russell 2000 stocks to steer clear of and some alternatives to watch instead.
Varonis Systems (VRNS)
Market Cap: $2.55 billion
Beginning with protecting Windows file shares in 2005 and evolving into a comprehensive security platform, Varonis Systems (NASDAQ: VRNS) provides data security software that helps organizations protect sensitive information, detect threats, and comply with privacy regulations.
Why Are We Wary of VRNS?
- Sales trends were unexciting over the last two years as its 11.8% annual growth was below the typical software company
- Costs have risen faster than its revenue over the last year, causing its operating margin to decline by 2.1 percentage points
- Projected 6.5 percentage point decline in its free cash flow margin next year reflects the company’s plans to increase its investments to defend its market position
At $21.74 per share, Varonis Systems trades at 3.5x forward price-to-sales. To fully understand why you should be careful with VRNS, check out our full research report (it’s free).
Sabre (SABR)
Market Cap: $569 million
Originally a division of American Airlines, Sabre (NASDAQ: SABR) is a technology provider for the global travel and tourism industry.
Why Are We Out on SABR?
- 15.7% annual revenue growth over the last five years was slower than its consumer discretionary peers
- Cash burn makes us question whether it can achieve sustainable long-term growth
- 7× net-debt-to-EBITDA ratio shows it’s overleveraged and increases the probability of shareholder dilution if things turn unexpectedly
Sabre is trading at $1.44 per share, or 6.9x forward EV-to-EBITDA. Read our free research report to see why you should think twice about including SABR in your portfolio.
Scholastic (SCHL)
Market Cap: $825.3 million
Creator of the legendary Scholastic Book Fair, Scholastic (NASDAQ: SCHL) is an international company specializing in children's publishing, education, and media services.
Why Do We Avoid SCHL?
- Lackluster 6.4% annual revenue growth over the last five years indicates the company is losing ground to competitors
- Ability to fund investments or reward shareholders with increased buybacks or dividends is restricted by its weak free cash flow margin of 13.9% for the last two years
- Waning returns on capital from an already weak starting point displays the inefficacy of management’s past and current investment decisions
Scholastic’s stock price of $38.75 implies a valuation ratio of 17.7x forward P/E. If you’re considering SCHL for your portfolio, see our FREE research report to learn more.
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