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Buy Small-Cap Bargain Stocks for Big Returns

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After a smooth ride last year, the U.S. stock market has seen a shaky start to 2015 due to a mountain of woes and heightened volatility. The biggest challenge – persistent slide in oil price – has trapped the global economy into a vicious circle of slow growth and deflation.

This is especially true as Japan slipped into recession, Europe is struggling, and developing markets like China and Brazil are experiencing a slowdown. Both the World Bank and International Monetary Fund (IMF) recently cut their growth forecast for the next two years.

The World Bank projects global economic expansion of 3% this year and 3.3% in the next, down from 3.4% and 3.5%, respectively. On the other hand, IMF lowered its global growth outlook to 3.5% from 3.8% for 2015, and 3.7% from 4% for 2016.

Further, a surging U.S. dollar is making exports less competitive, thereby hurting the sales and profit margins of the big American firms. Added to the huge uncertainty is the prospect of the interest rate hike by the Fed sometime this year that will continue to support the strength in dollar.  

U.S. Economy Looks Stronger Than Others

Amid widespread fears, the world’s largest economy has been defying the sluggish international fundamentals. This trend will likely continue in the coming months given improving business and job conditions, and rising consumer confidence. In fact, U.S. consumer sentiment jumped to 98.1 in January from 93.6 in December, as per the Thomson Reuters/University of Michigan. The final reading represents the highest level in 11 years.

While the U.S. expanded at a moderate rate of 2.5% in the last quarter of 2014, following two strongest quarters of growth back-to-back, it is still above 2.5% reflecting its growth potential. Additionally, this slow growth is probably a short-lived one, given the enormous backing from low gasoline price, which is actually driving consumer spending.

Consumer spending, which accounts for more than two-thirds of U.S. economic growth, climbed 4.3% in the fourth quarter. This is up from 3.2% in the third quarter and represents the fastest growth since the first quarter of 2006. Further, the U.S. is the only major country saw its outlook being raised by the major international agencies last month. The IMF upped the U.S. growth rate outlook by 0.5% to 3.6% for this year while World Bank expects economic growth to accelerate by 3.2% this year versus the previous expectation of 2.4%.

Given this, the U.S. economy will continue to exhibit resilience and overcome global concerns, benefiting small caps the most.

Why Small Caps?

Small caps ensure higher returns when the American economy is arguably leading the way. This is because these stocks are closely tied to the U.S. economy and generate most of their revenues from the domestic market, making them safer bets during a global turmoil than their large and mid cap counterparts.

Further, since these companies are small, they are poised to grow higher than the already tapped out large-cap players. As such, small caps seem to be the perfect choice for now. However, these stocks are risky options as these could lead to extreme volatility since huge gains and losses can occur in a very little time.

While there are a number of small stocks (market cap of less than $1 billion) that are poised to outperform amid improving American economic health, a look at a few stocks having a Zacks Rank #1 (Strong Buy) or #2 (Buy) in the small-cap space could be an excellent idea. Top-ranked stocks indicate rising earnings estimates, and stocks with strong earnings momentum are more likely to outpace the market.

Further, we have refined our list by using the Zacks Stock screener by searching for ultra-cheap stocks that have a P/E ratio under 10 and P/B ratio under 3. Thus, we uncover the three best bets twith which investors could fill in their portfolio for above-market returns:

Stocks to Buy

Lake Shore Gold Corp.

Based in Toronto, Lake Shore Gold is a gold mining company that is engaged in the exploration, development and operation of gold properties in Northern Ontario and Quebec. It has seen an upward earnings estimate revision of 3 cents for the current year to 11 cents over the past 30 days.

The Zacks Consensus Estimate represents increases of 57.14% for earnings and 2.5% for revenue from the past year. The growth rate of this company is inspiring, considering negative industry growth averages of 6.2% and 22.8%, respectively.

Lake Shore Gold currently trades at P/E ratio of 8 and P/B ratio of 0.9 versus the industry average of 16.5 and 1.8, respectively. It has a Zacks Rank #2 and belongs to industry Rank in the top 39%.

Ladder Capital Corp. (LADR - Free Report)

Based in New York City, Ladder Capital is a leading commercial real estate finance company that originates and invests in a diverse portfolio of commercial real estate and real estate-related assets, focusing on senior secured assets. The stock has seen solid earnings estimate revisions of 18.7% to $2.03 over the past 30 days for the current fiscal year.

In fact, the Zacks Consensus Estimate reflects substantial earnings growth of 61.35% and revenue growth of 18.5% for the current year. This is in contrast to the industry averages of 9.2% for earnings and 5.8% for revenues.

Ladder Capital has a P/E of 9.5 and P/B of 0.7, much below the industry averages of respective 12 and 1.5. The stock has a Zacks Rank #1 and industry Rank in the top 34%.

Ashford Hospitality Trust, Inc. (AHT - Free Report)

Based in Dallas, Ashford Hospitality is a real estate investment trust (REIT) engaged in the investment and management of properties in the hospitality industry across the United States. The stock has seen upward earnings estimate revisions of 2 cents for the current year over the past 30 days.

The 2015 Zacks Consensus Estimate represents a year-over-year increase of 21.20% for earnings and 14.8% for revenues. Both are much higher than the industry growth of 7.4% for earnings and 7.5% for revenues.

The stock trades at a P/E of 8.6 and P/B of 1.6, a massive discount to the industry average P/E ratio of 17 and P/B ratio of 2.6. This reflects that AHT is undervalued at current levels and bodes well for future growth given its Zacks Rank #1 and industry Rank in the top 22%.

In-Depth Zacks Research for the Tickers Above

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Ashford Hospitality Trust Inc (AHT) - free report >>

Ladder Capital Corp (LADR) - free report >>

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