The Russell 2000 (^RUT) is packed with potential breakout stocks, thanks to its focus on smaller companies with high growth potential. However, smaller size also means these businesses often lack the resilience and financial flexibility of large-cap firms, making careful selection crucial.
The high-risk, high-reward nature of the Russell 2000 makes stock selection critical, and we’re here to guide you toward the right ones. That said, here are three Russell 2000 stocks to steer clear of and some alternatives to watch instead.
Mayville Engineering (MEC)
Market Cap: $849.7 million
Originally founded solely on tool and die manufacturing, Mayville Engineering Company (NYSE: MEC) specializes in metal fabrication, tube bending, and welding to be used in various industries.
Why Does MEC Give Us Pause?
- Sales tumbled by 4.3% annually over the last two years, showing market trends are working against it during this cycle
- Earnings per share have dipped by 42.7% annually over the past two years, which is concerning because stock prices follow EPS over the long term
- High net-debt-to-EBITDA ratio of 5× increases the risk of forced asset sales or dilutive financing if operational performance weakens
Mayville Engineering’s stock price of $32.49 implies a valuation ratio of 62.6x forward P/E. To fully understand why you should be careful with MEC, check out our full research report (it’s free).
Sphere Entertainment (SPHR)
Market Cap: $4.96 billion
Famous for its viral Las Vegas Sphere venue, Sphere Entertainment (NYSE: SPHR) hosts live entertainment events and distributes content across various media platforms.
Why Do We Avoid SPHR?
- Muted 18.7% annual revenue growth over the last five years shows its demand lagged behind its consumer discretionary peers
- Projected 11.6 percentage point decline in its free cash flow margin next year reflects the company’s plans to increase its investments to defend its market position
- EBITDA losses may force it to accept punitive lending terms or high-cost debt
At $139.10 per share, Sphere Entertainment trades at 17x forward EV-to-EBITDA. Check out our free in-depth research report to learn more about why SPHR doesn’t pass our bar.
Origin Bancorp (OBK)
Market Cap: $1.64 billion
Founded in 1912 during the early boom days of Louisiana banking, Origin Bancorp (NYSE: OBK) is a financial holding company that provides personalized banking services to businesses, municipalities, and individuals across Texas, Louisiana, and Mississippi.
Why Are We Wary of OBK?
- Sales trends were unexciting over the last five years as its 8.2% annual growth was below the typical banking company
- Annual earnings per share growth of 6.8% underperformed its revenue over the last five years, showing its incremental sales were less profitable
- Capital generation will likely be soft over the next 12 months as Wall Street’s estimates imply tepid tangible book value per share growth of 9%
Origin Bancorp is trading at $53.18 per share, or 1.2x forward P/B. Read our free research report to see why you should think twice about including OBK in your portfolio.
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