Small-cap stocks in the Russell 2000 (^RUT) can be a goldmine for investors looking beyond the usual large-cap names. But with less stability and fewer resources than their bigger counterparts, these companies face steeper challenges in scaling their businesses.
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. Keeping that in mind, here are three Russell 2000 stocks that don’t make the cut and some better choices instead.
Varonis Systems (VRNS)
Market Cap: $3.70 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?
- Revenue increased by 11.7% annually over the last two years, acceptable on an absolute basis but tepid for a software company enjoying secular tailwinds
- Costs have risen faster than its revenue over the last year, causing its operating margin to decline by 2.7 percentage points
- Capital intensity will likely increase as its free cash flow margin is anticipated to drop by 1.9 percentage points over the next year
At $31.43 per share, Varonis Systems trades at 5.2x forward price-to-sales. Read our free research report to see why you should think twice about including VRNS in your portfolio.
Funko (FNKO)
Market Cap: $154.9 million
Boasting partnerships with media franchises like Marvel and One Piece, Funko (NASDAQ:FNKO) is a company specializing in creating and distributing licensed pop culture collectibles.
Why Is FNKO Risky?
- Annual sales declines of 9.7% for the past two years show its products and services struggled to connect with the market
- Eroding returns on capital from an already low base indicate that management’s recent investments are destroying value
- 7× net-debt-to-EBITDA ratio makes lenders less willing to extend additional capital, potentially necessitating dilutive equity offerings
Funko’s stock price of $2.83 implies a valuation ratio of 2x forward EV-to-EBITDA. Check out our free in-depth research report to learn more about why FNKO doesn’t pass our bar.
CSG (CSGS)
Market Cap: $2.11 billion
Powering billions of critical customer interactions annually, CSG Systems (NASDAQ:CSGS) provides cloud-based software platforms that help companies manage customer interactions, process payments, and monetize their services.
Why Are We Out on CSGS?
- Muted 2.3% annual revenue growth over the last two years shows its demand lagged behind its business services peers
- Modest revenue base of $1.22 billion gives it less fixed cost leverage and fewer distribution channels than larger companies
- Anticipated sales growth of 1.7% for the next year implies demand will be shaky
CSG is trading at $78.54 per share, or 15.5x forward P/E. To fully understand why you should be careful with CSGS, check out our full research report (it’s free for active Edge members).
High-Quality Stocks for All Market Conditions
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