2024 started with the expectations that inflation had already peaked and central banks across developed countries would start cutting rates this year, leading to strong rallies for market indexes, especially large caps. With this macro backdrop, we think small-caps in general have room to run to narrow the discount in valuation compared to large-caps in general.

The likes of Constellation Software (CSU) and Boyd Group Income (BYD), both graduated as small-cap companies and then continued to perform exceptionally well over many years. More than ever, we think investors can find many high-quality Canadian small-cap names with solid fundamentals in terms of growth prospects and returns on equity, and yet are trading at an attractive discount relative to US peers. 

One of the key filters we use is to look for companies with share prices that trade within the range of 52-week highs and continue to grind to new highs as time goes by. Although it is psychologically challenging for investors to pay up for a company share price trading at the highs. However, we think this is a powerful indicator mainly because (1) it is a strong signal that something is going right at the company and investors have started to recognize it, for example, the company is growing earnings faster than the market expected or a few catalysts are taking place such as the initiation of dividends, share repurchases, etc. (2) Great companies with strong growth likely stay in the trading range of 52-week highs rather than lows, and great compounders will continue to exceed previous highs. 

Below we have screened for companies with the following criteria:

• Market cap smaller than $5 billion but larger than $100 million
• Return on equity of at least 15%
• Trading at below 52-week highs in the range -5%
• 5-year Earnings before interest and taxes (EBIT) growth of at least 8%

Here is the screener:

The criteria for the screen are quite simple as we screen companies that are over $100 million but less than $5 billion in market cap, as these companies have had a decent operating track record for investors to evaluate, and are still relatively small, we feel these names could be less well-known to the majority of mainstream investors. Secondly, we screen for companies with a Return on Equity of at least 15%, and EBIT growth of at least 8% on average in the last few years, we think these criteria would tend to filter companies with solid fundamentals in terms of growth and profitability.

Lastly, we look for companies that are currently trading within 5% of their 52-week highs. We think these companies are experiencing solid momentum in their share prices. We like companies with strong momentum in share price but the improvements in fundamentals are even more meaningful than the share price reflects. For instance, a share price may go up 25% in a period when its fundamentals improve by 50%, which can still make it a sensible purchase despite the price tag. In addition. 52-week highs are a good tool to screen for small-cap companies that are less well-known, less-covered companies with decent fundamentals in this market environment.

The screener came up with 16 names, members will recognize some of the names that we cover in our Model Portfolios and coverage lists such as Hammond Power Solutions (HPS.A) and TerraVest Industries (TVK).

Again, these companies on the list are not recommendations but a starting point that helps investors generate potential investment ideas and strategies. Investors can view our previous screener blog here.

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Disclosure: The analyst(s) responsible for this report do not have a financial or other interest in the securities mentioned.