How to Find Profitable Small Cap Stocks

The Russell 2000 may have a profitability problem.

Although the small-cap index rose 10.1% in July, it is down about 4% so far in August as of Thursday morning.

ALPS’ Paul Baiocchi attributes the volatile moves to the overall composition of the index, with an estimate from Apollo Global showing 40% of these companies have negative profits.

“[Investors] have essentially resigned themselves to the fact that by participating in the Russell 2000, I’m just going to have to take the good with the bad,” the firm’s chief ETF strategist told CNBC’s “ETF Edge” this week.

To avoid the negative impact on profitability, Baiocchi suggests investors prioritize quality companies and look at more selective exchange-traded funds, such as his company’s funds. ALPS O’Shares US Small-Cap Quality Dividend ETF Shares (OUSM).

“The idea is that quality companies that pay and grow their dividends, and importantly, have less volatility than their peers,” he said. “It offers advisors and investors who have seen small caps trend sideways for five years the opportunity to be placed in a laggard category.”

Beyond the profitability screen, the fund contains just 107 stocks – a fraction of what’s in the Russell 2000. The top three investments are Tradeweb Markets, Juniper Networks And Old Republic Internationaleach with a roughly 2% weighting in the fund, per FactSet.

The small-cap fund’s shares are down 1.5% year to date – outperforming the Russell by more than 2 percentage points in that time.

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