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Is Small-Cap Investing Dead?

China worries, oil price cratering and global growth worries has put small-cap stocks in the chokehold.

But small-caps, by nature, are more volatile and see a greater pullback during downturns. The Russell 2000 is off more than 20% in the last six months. Year-to-date, the Russell 2000 is down twice as much as the S&P 500.

Late last year, Goldman Sachs (NYSE: GS) profiled a handful just as they held their annual U.S. small cap growth conference.

Among them were AMC Entertainment (NYSE: AMC), Penn National Gaming (NASDAQ: PENN) and Ruckus Wireless (NASDAQ: RKUS) - all three of which are already down 20% in just the last six months.

11 out of the 12 names that Goldman highlighted are negative in 2016. It’s dark out there for small-cap investors.

The recent lackluster performance has all but wiped out the premium gains the small-caps have seen since the financial crisis.

However, this is not the time to abandon U.S. small-cap companies.

The beauty of small-caps is their exposure to one primary economy, little currency worries and nimbleness to refocus their business and resources.

In truth, now is the time to be more excited than ever about small-caps. The valuations are attractive - yes, there is a such thing as value investing in small-caps - especially when compared to larger-caps.

Relative to large-caps, small-cap stocks haven’t been this cheap since 2003 - as measured by the Russell 2000 valuations versus the Russell 1000.

Source: AllianceBernstein

And there’s never been a better time to go value hunting in small-caps. The gap between the most overvalued and undervalued small-cap stocks, based on valuation measures and growth, hasn’t been this wide since 2011.

Now, I understand that if the market is poised to take a turn lover, small-caps look scary here. The key is to look for small-caps with revenue streams that are relatively insulated from the broader economy - such as Energizer Holdings (NYSE: ENR), where you’re going to be buying batteries regardless of the broader economy. But this is also a great time to pick up small-caps that have structural and demographic tailwinds or that have started to turn around but not yet caught Wall Street’s attention.

Warren Buffett has famously said that with just $1 million, and the implied free reign to invest in small-cap stocks, that he could generate 50% returns a year. In truth, this is exactly how Buffett made a lot of his money. Back in 1990 when Buffett invested $300 million in Wells Fargo (NYSE: WFC), it was a $2 billion small-cap bank.

With that in mind - we’re turning small-cap investing on its head. As part of a new endeavor to flip the script on small-cap investing, we’re rolling out a free email newsletter dedicated to offering insights into underrated small-cap stocks.

We sent out the above article to subscribers last week. It's non-spam, non-sponsored, non-penny stock content and ideas from myself and ValueWalk’s own Jacob Wolinsky - subscribe here to get the posts as soon as we send them out. We’ll be tapping into some of the most underrated hedge fund managers in the market to help us in our journey.

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