Wells Fargo says buy small caps over large caps. Here are 10 favorites

Published Tue, Nov 8 20222:36 PM ESTUpdated Wed, Nov 9 20228:46 AM EST

Small-cap stocks in Wells Fargo's portfolio are poised to outperform their larger counterparts. Analyst Christopher Harvey said the firm's small-cap, high-quality portfolio is down 5.9% year to date through October, outperforming the Russell 2000 index, which lost 16.9%. "Last year we said small-cap Quality was historically mispriced, but did not think the macro environment favored small caps over large caps," he said in a Monday note to clients. "Going forward, we still believe in a High Quality approach, and we now expect small caps to outpace large caps." Harvey said small caps are technically oversold, but they are beginning to "bounce" while having "more attractive" valuations. He also said per-share earnings revisions for small-cap companies have "beaten the rush," meaning they adjusted faster to the changing economic backdrop than large caps have. The companies that started preparing early for EPS drops offer a slightly better risk-reward ratio, he said. This move is a broader step from when Wells Fargo turned positive on small-cap growth in February. He said it was prompted by the small-cap portfolio moving in line with the S & P 500 and starting to outperform the Russell 1000 Growth Index. The portfolio includes about three dozen stocks that Wells Fargo calls "high quality" small caps. To determine quality, the firm looked at net debt, EBITDA, returns and net margins. Harvey recently added Ollie's Bargain Outlet and green energy name Brookfield Renewable to the portfolio, while increasing exposure to equipment rental firm HERC Holdings and equipment manufacturer Terex . He removed packaging company Greif and home builder Century Communities , while also decreasing exposure to IONIS Pharmaceutical . Among the stocks included in the portfolio is Delek , a downstream energy company whose share price has more than doubled this year. When reporting quarterly earnings Monday, the company beat expectations on the top and bottom lines. IONIS, which he recently reduced exposure to as a way to reduce risk, has added 37% so far this year. The biopharmaceutical company is known for its RNA-targeted therapies and announced positive results last week from the 2b phase of its study of a medicine that could prevent thrombosis, which occurs when blood clots stop flow to arteries or veins. But not all companies in the portfolio are performing so well this year. Entertainment company IMAX has lost 24% in 2022. — CNBC's Michael Bloom contributed reporting.