The Russell 2000 (^RUT) is home to many small-cap stocks, offering investors the chance to uncover hidden gems before the broader market catches on. However, these companies often come with higher volatility and risk, as their smaller size makes them more vulnerable to economic downturns.

Navigating this part of the market can be tricky, which is why we built StockStory to help you separate the winners from the laggards. That said, here are three Russell 2000 stocks to steer clear of and some alternatives to watch instead.

Lovesac (LOVE)

Market Cap: $205.2 million

Known for its oversized, premium beanbags, Lovesac (NASDAQ: LOVE) is a specialty furniture brand selling modular furniture.

Why Are We Out on LOVE?

1. Sales trends were unexciting over the last five years as its 16.8% annual growth was below the typical consumer discretionary company
2. Projected 2.5 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
3. Eroding returns on capital from an already low base indicate that management’s recent investments are destroying value

Lovesac’s stock price of $14.04 implies a valuation ratio of 7.8x forward EV-to-EBITDA. Read our free research report to see why you should think twice about including LOVE in your portfolio.

CNO Financial Group (CNO)

Market Cap: $3.77 billion

Rebranded from Conseco in 2010 to signal a fresh start after navigating financial challenges, CNO Financial Group (NYSE: CNO) develops and markets health insurance, annuities, and life insurance products primarily targeting middle-income pre-retirees and retirees.

Why Do We Pass on CNO?

1. Insurance offerings faced market headwinds this cycle, reflected in stagnant net premiums earned over the last five years
2. Day-to-day expenses have swelled relative to revenue over the last two years as its pre-tax profit margin fell by 2.3 percentage points
3. Products and services are facing significant credit quality challenges during this cycle as book value per share has declined by 7.2% annually over the last five years

At $40.19 per share, CNO Financial Group trades at 1.3x forward P/B. To fully understand why you should be careful with CNO, check out our full research report (it’s free).

Live Oak Bancshares (LOB)

Market Cap: $1.49 billion

Founded during the 2008 financial crisis with a vision to reimagine small business banking through technology, Live Oak Bancshares (NYSE: LOB) is a bank holding company that specializes in providing online banking services and SBA-guaranteed loans to small businesses across targeted industries nationwide.

Why Are We Cautious About LOB?

1. Net interest margin of 3.3% reflects its high servicing and capital costs
2. Performance over the past two years shows its incremental sales were much less profitable, as its earnings per share fell by 6.4% annually

Live Oak Bancshares is trading at $32.27 per share, or 1.1x forward P/B. Dive into our free research report to see why there are better opportunities than LOB.

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