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jennifer dowty

Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market.

Small caps outperformed the broader index during the first half of the year by a wide margin. The S&P/TSX small cap index rallied 26 per cent, while the S&P/TSX composite index appreciated 8 per cent. However, that was because of the heavy weighting in resource stocks within the small-cap index.

Interestingly, if you break the indexes down to individual names, the S&P/TSX small-cap index actually had a greater percentage of securities with negative returns. Within that index, 32 per cent of securities delivered negative price returns during the first half of the year, compared with 28 per cent in the composite. To be profitable when investing in stocks with small capitalizations, successful security selection was crucial.

Let's take a closer look at what individual small-cap stocks the experts, analysts on the Street, believe will deliver solid returns over the next year.

In the accompanying table, we list three stocks from each sector within the S&P/TSX small-cap index that are anticipated to deliver the highest returns over the next year, with one caveat: They must also have realized positive returns during the first half of the year. This exclusion eliminated underperforming stocks.

Forecast price returns listed are based on the closing prices from the final trading day of June.

Let's begin with the consumer discretionary sector, which was a hit or miss for investors. Within this sector, 45 per cent of stocks realized positive price returns in the first half compared with 55 per cent that delivered negative returns. The three stocks with the highest expected returns over the next 12 months are Intertain Group Ltd., Yellow Pages Ltd. and Great Canadian Gaming Corp.

Yellow Pages is a stock that has performed well year-to-date and analysts on the Street have bullish expectations with the one-year target prices ranging from $24 to $30. Given declining print revenue, management is focused on growing its digital revenue. While analysts have high expectations for this company, I would caution long-term investors, as the firm's transition to greater digital revenue may have its challenges, a risk to consider.

For investors seeking income, EnergCare Inc. is forecast by analysts to deliver a modest, single-digit price return over the next year. It also pays investors an attractive dividend yield of approximately 5 per cent, which appears sustainable. In addition, the recent acquisition of Service Experts is expected to be accretive to distributable cash per share.

Small-cap consumer-staples stocks were solid performers in the first half of the year, with all eight securities reporting gains. The top three stocks with the highest forecast returns over the next 12 months are AGT Food and Ingredients Inc., Clearwater Seafoods Inc. and KP Tissue Inc.

The anticipated sector leader, AGT, has a forecast price return of more than 20 per cent; however, investors may need some patience as the company is adding production capacity to support its growth. Earnings are forecast to growth materially in 2017. The consensus earnings before interest, taxes, depreciation and amortization (EBITDA) is $128-million in 2016, rising 13 per cent to $145-million in 2017.

Analysts have attractive double-digit projected returns for numerous energy stocks. In fact, only five of the 41 stocks in the S&P/TSX small-cap index have negative price returns forecast over the next year, while 33 stocks have double-digit returns forecast. In other words, analysts believe that the majority of stocks in this sector have meaningful upside potential. Among the expected leaders are service stocks High Arctic Energy Services Inc., Savanna Energy Services Corp. and PHX Energy Services Corp.

In addition to an anticipated stellar price return, the sector leader, High Arctic, pays shareholders a monthly dividend of 1.65 cents per share, equating to an annualized yield of approximately 5 per cent.

Turning to financials, Dundee Corp., Dream Unlimited Corp. and Chesswood Group Ltd. are anticipated to deliver solid gains. Furthermore, as per recent analysts' reports from this year, each of these securities only has buy recommendations, with with no holds or sells. Another notable mention is Mainstreet Equity Corp., with expectations of a price return exceeding 20 per cent over the next year.

For investors partial to real estate investment trusts, three REITs in the small-cap index with unanimous buy recommendations are American Hotel Income Properties REIT LP with six buy recommendation and an average one-year price target of $12.46, as well as two defensive residential REITs, Morguard North American Residential REIT with four buy recommendations and a one-year price target of $13.75, and Milestone Apartments REIT with nine buy recommendation and a 12-month target of $20.17. However, these residential REITs have limited upside forecast given their strong price moves.

For investors seeking exposure to the, at times, extremely volatile health-care sector, Theratechnologies Inc., Cipher Pharmaceuticals Inc. and TSO3 Inc. all have impressive forecast returns. Speaking of volatility, since the end of the second quarter, the average one-year price target for Theratechnologies has been materially revised down to $3.97 from $4.82 as an analyst downgraded the stock and reduced his target price. Conversely, the average one-year price target for TSO3 has increased significantly to $5.13 from $3.28 on June 30 after the company announced on July 4 the U.S. Food and Drug Administration cleared its Sterizone VP4 Sterilizer for expanded indications for use. Other health-care stocks with double-digit returns forecast are CRH Medical Corp. and Knight Therapeutics Inc. with average one-year target prices of $6.41 and $9.60, respectively.

Next up is the industrial sector. Magellan Aerospace Corp., Stuart Olson Inc. and New Flyer Industries Inc. all had expected price returns that topped 20 per cent as of June 30. However, Stuart Olson has since realized sharp price recovery, reducing its forecast return to approximately 14 per cent. In this sector, there were only two stocks out of 27 with negative forecast returns, Ag Growth International Inc. and Russel Metals Inc. Both experienced large price moves during the first half of the year, rising 23 per cent and 42 per cent, respectively.

Of these three anticipated leaders, bus manufacturer New Flyer has been a solid stock over the years and its prospects remain bright given its anticipated synergies from its recent acquisition, reasonable dividend yield and recent announcements of new contract awards set to drive the company's growth.

Shares of Stuart Olson plunged after the construction-services company announced last month its second-quarter earnings would be negatively affected from the recent wildfires in Alberta. However, the share price has recently snapped back. The stock has strong downside support with its generous dividend topping 7 per cent and its reasonable valuation relative to historical levels.

Information technology has been a challenging sector for some investors to have positions in, with 57 per cent of the stocks in this sector realizing negative returns during the first six months of the year. Yet analysts have faith that these stocks will rebound, as 13 of the 14 stocks have positive returns forecast over the next 12 months. At the top of the list are Wi-LAN Inc., Halogen Software Inc. and Evertz Technologies Ltd. Shares of Evertz trade at a reasonable valuation; the company has a sizable cash position, providing downside support to the stock price; and the company pays investors an attractive dividend of 18 cents per share, equating to a yield of approximately 4 per cent.

In contract to the technology sector, the materials sector has been a gold mine to investors. Numerous gold stocks have delivered phenomenal returns, with continued gains expected for many of these stocks. Three securities with robust returns forecast are Nevsun Resources Ltd., Noranda Income Fund and Altius Minerals Corp. The list is quite lengthy of potential leaders. For gold bugs, intermediate gold producer Kirkland Lake Gold Inc. has an average one-year price target of $12.82. Kirkland has operations in Northeastern Ontario, and therefore does not face geopolitical risks as some gold companies do with their operations abroad.

Lastly, the utilities sector has been a mix bag of performance with five securities surging in value in the first half and three securities falling in value. Atlantic Power Corp., Innergex Renewable Energy Inc. and Boralex Inc. have all reported strong price moves, and as a result their positive price momentum is anticipated to wane with modest gains forecast. For investors seeking higher returns, the security with the highest forecast return in the sector but failing to make the list because of its roughly 5-per-cent unit price decline in the first half of the year is Crius Energy Trust. The Street is forecast a strong recovery in the unit price with a 12-month target of $11.96, suggesting a potential price return of approximately 40 per cent.

Small-cap expectations

Sector/CompanyTicker12m target price ($)Closing Price June 30 ($)Potential Price Rtn (%)
Consumer Discretionary
Intertain Group LtdIT-T 23.29 10.45 123
Yellow Pages LtdY-T 25.75 18.32 41
Great Canadian Gaming CorpGC-T 22.25 17.97 24
Consumer Staples
AGT Food & Ingredients IncAGT-T 43.86 35.49 24
Clearwater Seafoods IncCLR-T 17.17 13.98 23
KP Tissue IncKPT-T 14.25 12.36 15
High Arctic Energy Services IncHWO-T 6.19 4.06 52
Savanna Energy Services CorpSVY-T 2.31 1.64 41
PHX Energy Services CorpPHX-T 3.54 2.69 31
Dundee CorpDC.A-T 13.50 7.63 77
DREAM Unlimited CorpDRM-T 12.08 7.98 51
Chesswood Group LtdCHW-T 14.13 10.01 41
Health Care
Theratechnologies IncTH-T 4.82 2.70 79
Cipher Pharmaceuticals IncCPH-T 10.13 6.75 50
TSO3 IncTOS-T 3.28 2.24 46
Magellan Aerospace CorpMAL-T 23.00 18.01 28
Stuart Olson IncSOX-T 7.19 5.92 22
New Flyer Industries IncNFI-T 48.50 40.23 21
Information Technology
Wi-LAN IncWIN-T 4.47 3.28 36
Halogen Software IncHGN-T 11.43 8.50 34
Evertz Technologies LtdET-T 20.63 18.30 13
Nevsun Resources LtdNSU-T 6.10 3.79 61
Noranda Income FundNIF.UN-T 3.75 2.59 45
Altius Minerals CorpALS-T 14.50 10.80 34
Atlantic Power CorpATP-T 3.60 3.18 13
Innergex Renewable Energy IncINE-T 15.50 14.49 7
Boralex IncBLX-T 20.09 19.47 3

Source: Bloomberg