3 Small-Cap Stocks That Raise Our Concerns

Are Small-Cap Stocks Worth the Risk?

Investing in small-cap companies can offer significant upside, as these stocks are often overlooked by analysts, leading to potential undervaluation. However, their limited scale can make it challenging for them to strengthen their competitive advantages, which often keeps both their businesses and share prices from growing substantially.

Because of the risks involved with these types of investments, we created StockStory to help investors distinguish between long-term winners and those likely to underperform. With that in mind, let’s examine three small-cap stocks you may want to avoid, along with some alternatives worth considering.

Energy Recovery (ERII)

Market Capitalization: $569.5 million

Energy Recovery (NASDAQ:ERII) has made a significant impact by helping conserve over a trillion gallons of water. The company supplies energy recovery solutions to industries such as water treatment, oil and gas, and chemical processing.

Concerns About ERII:

• Revenue has grown by only 2.6% annually over the past two years, which falls short of what we expect from industrial companies.
• Analysts predict an 11.4% drop in revenue over the next year, suggesting a sharp decline in demand.
• Returns on capital are decreasing, indicating that the company’s most profitable opportunities may be drying up.

Currently, Energy Recovery shares are priced at $10.64, with a forward price-to-earnings ratio of 16.8.

City Holding (CHCO)

Market Capitalization: $1.69 billion

Founded in 1957, City Holding (NASDAQGS:CHCO) operates as a financial holding company, offering banking, trust, and investment services through its subsidiary, City National Bank. The company serves customers across West Virginia, Kentucky, Virginia, and Ohio, with a strong presence along the I-64 and I-81 corridors.

Why We’re Cautious About CHCO:

• Net interest income has increased by just 8.9% annually over the last five years, which is below our expectations for the banking industry.
• Projections show net interest income will rise only 3.5% in the coming year, indicating a slowdown from previous trends.
• Over the past two years, earnings per share have grown by just 5.6% annually, lagging behind the sector average.

City Holding trades at $117.73 per share, with a forward price-to-book ratio of 1.9.

Garrett Motion (GTX)

Market Capitalization: $3.44 billion

Garrett Motion (NYSE:GTX) plays a crucial role in the shift toward cleaner transportation by developing turbochargers, air compressors, and electric motor technologies for automotive and industrial clients.

Reasons for Concern with GTX:

• Revenue has declined by 4% annually over the past two years, as customers have delayed purchases.
• Wall Street expects only modest growth of 3.3% in the next year, pointing to continued weak demand.
• High production costs have resulted in a low gross margin of 19.8%, which the company must compensate for with higher sales volumes.

Garrett Motion’s shares are currently valued at $18.50, reflecting a forward P/E ratio of 9.9.

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