Small-cap stocks are a perennial favorite among retail investors. On average, small-cap stocks (as a category) outperform the overall market over a long enough period. Since analysts began breaking down market capitalization by category in the US, small-cap stocks returned more than 17% annually on average.
However, the upside potential is coupled with greater downside risk. Small-cap stocks are more prone to economic fluctuations and often sensitive to interest rate hikes. Small-cap companies have a much greater likelihood of bankruptcy than their larger counterparts. So, as times get lean, investors would be well-advised to consider which small-cap stocks they hold in a portfolio closely. Emphasizing fundamental strength and durability in down markets is key – and these small-cap stocks miss the mark.
Small-Cap Stocks: Workiva (WK)
Workiva (NYSE:WK) is a niche software as a service (SaaS) firm specializing in financial reporting, ESG, audit, and risk management. The stock went on a run this year, surging by 24%. But, in light of recent performance, this is one small-cap stock to reconsider.
Workiva reported total revenue of $155 million for the second quarter of 2023, marking an 18% increase from the same period in 2022. However, trouble is on the horizon as Workiva faces mounting debt and cash flow concerns. Critically, the company’s short-term liabilities nearly exceed its current cash and receivables balance. As debt costs increase, this could put downward pressure on the unprofitable company.
The risk is evident from the firm’s interest coverage ratio. The ratio details how easily a firm can pay interest expense from earnings. Workiva’s interest coverage ratio is an abysmal -16.91, meaning the firm cannot pay its current debt expense from earnings alone. This capital structure might have worked in an era of easy credit, but, today, belt-tightening puts this small-cap stock at risk of default.
Upstart Holdings (UPST)
Upstart Holdings (NASDAQ:UPST) is on a losing streak, and upcoming economic concerns aren’t liable to boost its ailing share price. The stock hit a high in July. Its momentum came from a rushing artificial intelligence (AI) wave, as much of its lending offerings center on AI-driven analytics.
But UPST’s core proposition is lending to those unable to find financing elsewhere. That puts this small-cap stock in a precarious position as rates remain “higher for longer” and increase the company’s debt cost alongside default risk for its borrowers.
Upstart’s personal loan interest rates range as high as 35.99% today and could climb even higher as its own borrowing costs increase. Consumer loan defaults are rising and inching close to a decade-long high. At the same time, consumer credit card debt is at an all-time high. High debt loads, high-interest rates, and climbing consumer default create a perfect storm that could wreck this small-cap stock.
Small-Cap Stocks: AMC Entertainment (AMC)
If you’re still holding AMC Entertainment (NYSE:AMC), time is running out to dump this small-cap loser. This week, analysts at Citi cut their price target by ⅔, indicating that $4.75 is a fair price to pay for the entertainment stock. That’s about half its current price and a fraction of this year’s high, indicating imminent further downward movement.
AMC’s reverse stock split scheme served as an early warning sign, as it did little to assuage investor concern. Next up is a massive dilution effort as AMC floods the market with 40 million new shares, cutting existing shareholder value substantially. Cash from the equity issue will pay down its hefty debt, a critical move as borrowing costs rise. Still, a last-ditch effort to remain solvent isn’t a good sign, and investors still holding out hope for this small-cap stock shouldn’t expect much.
Bark Inc. (BARK)
Subscription-based Bark Inc. (NYSE:BARK) is one small-cap stock that isn’t ready to play with the big dogs. The company, boosted during 2021’s SPAC craze, trades at a fraction of its post-merger high. Firmly in penny stock territory, there’s little room for the stock to fall further. At the same time, though, there’s limited upside ahead.
Perennially unprofitable, the company’s sales are continually slipping. Discretionary spending is the first to go in a constrained economy, with households watching their budget closely. And few products are as discretionary as (admittedly high-quality) dog toys sent on a subscription basis.
At this point, BARK’s best hope is a buyout. The company has been a long-time strategic partner with retailer Target (NYSE:TGT), which could bolster its acquisition potential. Still, this small-cap stock doesn’t have a strong future without a saving grace soon.
Small-Cap Stocks: Nikola (NKLA)
Nikola (NASDAQ:NKLA) is hanging on by a thread despite a recent share price jump on the heels of a new executive hire. But the new exec, despite experience in the car industry, won’t be enough to save this small-cap stock.
Most concerningly, the company’s rapid cash burn pushed the firm to push convertible notes in a last-ditch effort to maintain liquidity. The notes pay 5% annually, which is pricey for a firm already losing cash hand-over-fist. Its cash concerns are amplified by ongoing battery recall initiatives, a costly endeavor that simultaneously eats into the firm’s bottom line without generating any revenue in return.
Fraud convictions were the beginning of the electric car stock’s trouble but by no means the end. Pushing dilutive notes onto a disinterested market that also serves to eat limited cash might be the final nail in the company’s coffin. If you still hold this small-cap stock, now is the time to move on.
Small-Cap Stock: Opendoor Technologies (OPEN)
A strong (but declining) housing market won’t save Opendoor Technologies (NASDAQ:OPEN) from significant trouble. Home prices are dipping slightly, but the seller’s market is long past over. This time last year, homes sat on the market for slightly more than a month before selling. Today, homes are sitting stagnant for nearly double that, and the trend is rising. Combine a stale housing inventory with continued interest rate elevation, and it’s clear why Citi analysts further downgraded the stock this week.
Earlier this month, CEO Wheeler Carrie offloaded $1.98 million in shares. Execs sell stock for innumerable reasons. But, at this price, it’s curious that she’s seemingly running for an exit before shares decline further. For those holding this small-cap real estate stock, follow the CEO’s lead and sell.
Peloton (PTON)
Peloton’s (NASDAQ:PTON) luxury product popularity is a losing proposition in today’s economy, and its rigid reliance on a niche demographic doesn’t leave much room to rebound. Peloton’s churn rate is running wild, as total members fell by 5% in the most recent report, and total app subscriptions fell by 13%. Like BARK, this is likely due to penny-pinching at the household level as “nice to have” subscription-based products get tossed first.
Peloton’s popularity isn’t helped by a slew of product recalls, either. Likewise, increased unplanned insider sales might be a warning sign for investors riding the Peloton stock cycle to jump off before it’s too late.
On the date of publication, Jeremy Flint held no positions in the securities mentioned. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.