7 Best Buys Among Small-Cap and Mid-Cap Stocks

In his specialty service, Upside, quantitative expert Richard Moroney uses a proprietary ranking system called Quadrix, which rates stocks using 90 variables in seven categories. Here, the contributor to MoneyShow.com highlights his seven best buys among small and mid-cap caps stocks for investors with a 12-month horizon. For more than 20 years, we have scoured the market for the best small and mid-cap stocks, rating only our 12 to 20 favorites as Best Buys. Although there have been occasional disappointments, this focused approach has served us well over the years. Rounding the midway point on 2019, Upside's Best Buy List is up 21%, while the broader Buy List is up 16%. That compares to gains of 14% for the Russell 2000 Index and 10% for the S&P SmallCap 600 Index. Our Best Buy list has a clear cyclical bias. We are most exposed to the industrials (50% of components) and technology (32%) sectors. We are having a harder time finding attractive picks in the materials, health-care, consumer staples, and communication-services sectors. Increasingly, we are willing to pay a modest premium for stocks with superior growth prospects. Stocks on our Best Buy list trade at an average of 18 times estimated current-year profits, while the S&P SmallCap 600 and MidCap 400 indexes have median forward P/E ratios of 16. Per-share profits are expected to grow 19% and sales 10% this year for the average Best-Buy rated stock. Their peers are projected to generate mid-single digit growth for both metrics. Of course, we do not like all the stocks on our Best Buy list equally. Here's a look at our seven top picks for capital gains over the next 12 months. Ciena A leading maker of networking gear, Ciena is projected to increase per-share earnings by 44% this year and by 23% in 2020. Strong demand for its optical gear, which carries video, data, and voice traffic across fiber cables, reflects robust capital spending by AT&T and Verizon , the company's largest customers. Product rollouts are helping drive growth, and Ciena is gaining market share at the expense of smaller optical equipment vendors. Management offered a bullish long-term outlook, saying per-share earnings should increase more than 20% annually. For fiscal 2019 ending October, Wall Street targets per-share earnings of $2.00, above the consensus of $1.83 just one month ago. Revenue is expected to hit $3.5 billion, up 14%. A midyear capital-gains favorite, Ciena is rated Best Buy. Woodward Despite uncertainty surrounding the beleaguered 737 MAX jetliner from Boeing , Woodward says demand for new fuel-efficient aircraft is driving growth, fueled by continued strength in global passenger and cargo traffic. The company makes components and systems for airplanes and helicopters, with Boeing accounting for roughly 12% of annual revenue. Aided by a shift to natural gas, Woodward's industrial business sells power convertors and is benefiting from the increased use of gas turbines. The stock earns a Quality score of 81 and Performance rank of 87. Woodward shares have rallied some 52% for the year yet still look reasonably valued due to their growth profile. For the 12 months ended March, sales grew 25%, per-share earnings surged 53%, and free cash flow more than doubled. For fiscal 2019 ending September, per-share earnings are expected to jump 27% to $4.87, reflecting improved productivity and fatter margins. Revenue is projected to advance 23%. The stock, a midyear capital-gains favorite, is a Best Buy Atkore International Atkore makes products that are primarily used in the construction market, which continues to enjoy upbeat sentiment. It makes electrical-raceway products, the fittings and trays that protect wires and cables from heat, corrosion, and water. The U.S. accounts for 90% of total sales. The stock earns the maximum Quadrix Overall rank of 100, supported by scores exceeding 80 for five of six categories. Atkore's middling Financial Strength rank of 38 is partly due to its heavy debt load and low profit margins. But its profit margins are steadily improving. And Atkore should benefit if the Federal Reserve cuts rates, considering a significant portion of its debt carries variable interest rates. Consensus per-share-profit estimates are marching higher for both 2019, projected to grow 20%, and 2020, 6%. Although Atkore shares have risen 5% over the past couple months, they trade at just eight times estimated 2019 earnings, versus a median of 16 for the S&P 1500 Index industrials sector. Atkore is a Best Buy. Diodes After struggling for most of 2019, Diodes shares are starting to find their stride, rallying 9% since the end of May. Analyst estimates are rising, with the consensus projecting 29% profit growth for the June quarter and 21% growth for the year. Diodes should get a boost from wireless carriers building their 5G networks, the next generation of cellular connections. The company is supplying components used in base stations and cellular equipment attached to streetlights and utility poles. At just 13 times trailing earnings, the shares trade below the median of 19.5 for S&P 1500 Index semiconductor stocks and their own five-year median of 24. If Diodes meets the 2019 consensus profit estimate of $2.87 per share and its trailing P/E ratio climbs to 15, the shares would reach $43 over the next seven months. The company has topped consensus profit estimates in each of the past four quarters. Diodes, earning the maximum Quadrix Overall score of 100, is rated Best Buy. Generac Generac shares have been on a tear, climbing 39% over the past three months. The shares still look cheap, earning a Quadrix Value score of 61 and trading below peers and their own historical norms for both trailing earnings and estimated 2019 profits. Generac makes residential power generators and backup-power systems for U.S. wireless carriers. With the 5G rollout, Generac expects an extended investment cycle from wireless companies that could continue for the next couple years. Additionally, Generac anticipates higher demand for residential power generators in California as utility PG&E limits electric distribution during extremely dry and windy conditions to reduce the risks of another major wildfire. Although operating profit margins expanded in five of the past six quarters, Generac's profitability could get squeezed from the U.S. trade war with China. Consensus estimates expect 3% lower per-share profits in the June quarter, followed by an 8% decline in the September quarter -- despite sales growth. Those estimates may prove conservative, given that Generac stockpiled inventory in the months ahead of the latest round of tariffs to help insulate itself from higher costs. Generac is a Best Buy. Hexcel Hexcel produces carbon fiber materials, found in aircraft, satellites, and turbine blades. Lighter and more durable than aluminum, carbon fiber helps reduce operating and maintenance costs. The shares aren't cheap, trading at 21 times trailing earnings, versus a median P/E ratio of 18 for aerospace and defense stocks in the S&P 1500 Index. But we're willing to pay up for the stock, given Hexcel's growth prospects. Looking out over the next three years, management sees annual per-share profits climbing by double digits. Hexcel targets three-year annualized sales growth of 4% to 7% in the commercial-aerospace market (69% of sales for the 12 months ended March), 11% to 13% in space and defense (17%), and more than 10% in industrial (14%). Free cash flow is expected to total $1.8 billion over the next five years -- more than five times higher than what Hexcel generated in the past five years. For the 12 months ended March, free cash flow rose 20% to $169 million. Hexcel is a Best Buy. Quanta Services Quanta Services looks timely in Quadrix, scoring above 75 for Momentum, Value, Earnings Estimates and Performance. The shares are up some 27% this year. Yet they trade at just 11 times trailing earnings, below their five-year median of 20 and sector median of 17. Quanta is a specialty contractor for utility, pipeline, and telecommunication companies. North America represents 95% of revenue. Quanta has delivered 10 straight quarters of double-digit sales growth. A growing base business gives Quanta a greater stream of recurring revenue, helping protect it from the next downturn. The base business represents 90% of sales, up from 83% in 2015. For the June quarter, Quanta is expected to report per-share profits of $0.83, up 41%, on revenue of $2.89 billion, up 9%. Analyst estimates are trending higher for both 2019 and 2020. If Quanta meets the 2019 consensus profit estimate of $3.62 per share and its trailing P/E ratio rises to 13, the shares would reach $47 by early next year. Quanta is rated Best Buy.

7 Best Buys Among Small-Cap and Mid-Cap Stocks

These top picks are expected to produce attractive capital gains over the next 12 months.

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