Large capitalization stocks have been getting all the attention in 2024. The S&P 500 Index is up 14% year-to-date (YTD), and the Nasdaq 100 has rallied 17%. Meanwhile, the Russell 2000 Index of smaller companies is actually down fractionally YTD.
Good reasons exist for this discrepancy. The major indexes are full of fast-growing tech companies that are enjoying record profits right now. Meanwhile, the Russell 2000 Index is full of companies in less glamorous industries such as regional banking, utilities and healthcare which have missed out on much of the market’s recent enthusiasm.
Despite that, some serious pitfalls can still be found within the Russell 2000. While the index may seem cheap overall, these three Russell 2000 stocks to sell are absolute minefields set to blow up on unsuspecting investors later this year.
Super Micro Computer (SMCI)
Super Micro Computer (NASDAQ:SMCI) is now the quintessential example of an overvalued Russell 2000 company to sell before it crashes.
SMCI stock is now the largest holding in the Russell 2000 Index, making up 1.5% of the entire space as of this writing. That’s incredible, as most holdings are just 0.1% or 0.2% of the index, which is fitting for such a broadly diversified portfolio of companies. In fact, only one other company, Microstrategy (NASDAQ:MSTR), makes up more than 0.5% of the Russell 2000 Index today.
How did SMCI stock grow to be such an outlier? Its price is up almost 250% over the past year and more than 4,000% over the past five years.
Investors have become fascinated with the high-performance server and storage solutions company due to its products which go into artificial intelligence (AI) infrastructure. Super Micro Computer doubled revenues between 2019 and 2023. Further, analysts expect another doubling in 2024 before growth rapidly slows down thereafter.
SMCI has certainly enjoyed stellar top-line growth recently. However, it is still selling a commodity product with low profit margins. In fact, the company’s gross profit margin was merely 18% in 2023, up only slightly from the 15.2% profit margin it earned over the past decade on average.
By contrast, Nvidia (NASDAQ:NVDA) has a gross margin above 60%, and most software companies tend to run 70% or higher. A tech commodity hardware product from Super Micro Computer can make money for a time. But once the boom ends, profits tend to crash. SMCI stock is riding the AI wave. Yet the moment the tide starts to turn, Super Micro Computer shares will crash against the rocks.
Abercrombie & Fitch (ANF)
One of the oddest phenomena in the small cap space has been the rebound in mall retail stocks. Both Dillard’s (NYSE:DDS) and Abercrombie & Fitch (NYSE:ANF) have seen their shares rise tenfold from their pandemic lows. ANF has been particularly shocking, with shares rising more than 400% over the past year alone. This seems to be putting the cart ahead of the horse, as mall traffic is still slightly below pre-pandemic levels.
The company has enjoyed a sharp upturn in earnings over the past two years. Consumers have been shopping at a healthy rate since the economy reopened, as folks are prioritizing experiences in a form of what’s known as revenge spending.
This has benefitted retail companies, like Abercrombie & Fitch, that have been able to play the consumer trends well. There’s no taking anything away from the success that management has had over the past 18 months.
Nevertheless, Abercrombie & Fitch generated $4.3 billion in revenues in fiscal year 2024. That was up only slightly from the $3.7 billion that the company produced way back in 2015. At the same time, ANF stock was trading around $25 back then and now it’s at $185.
Needless to say, this sort of wild expansion in a company’s price-to-sales ratio is hard to maintain. Investors are placing way too high a multiple on near-term elevated profits tied to an unusual burst of consumer spending. When the next recession inevitably hits, ANF stock will end up back on the clearance rack.
AeroVironment (AVAV)
Last fall, I highlighted AeroVironment (NASDAQ:AVAV) as a defense stock set to explode higher. That worked out well, with AVAV stock doubling since then.
AeroVironment was the perfect stock for the moment. That’s because it produces a variety of drone units that don’t require any human pilots. This allows militaries to engage with enemy combatants from long distances without risking their own personnel.
Already, AeroVironment had developed a considerable business, and then the war in Ukraine threw this into overdrive. Ukranian allies have rushed to buy drones in a way to support the war cause without directly sending their own soldiers into battle.
This has worked wonders for AeroVironment’s earnings, with EPS set to double in fiscal year 2024 on a roughly 31% increase in revenues.
However, the issue is the sustainability of this increase. Analysts see earnings and revenue growth greatly decelerating next year. At some point, the war in Ukraine will slow down or there will be a ceasefire altogether.
With AVAV stock now trading at a stunning 77 times estimated 2024 earnings (and that during a wartime boom, no less) it’s hard to see any possible further upside from here. AeroVironment was a great trade. But it’s now turned into an exceptionally risky one giving the stunning valuation at today’s price.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.