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Is this small-cap stock a falling knife to catch after sliding 20% today?

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Buying shares which have fallen heavily can lead to high gains in the long run. They may offer a wide margin of safety, since investors may have priced in a worst-case scenario. However, in the short run they may be among the most volatile stocks in the index. This can lead to paper losses and may be a cause for concern for more risk averse investors.

Falling over 20% today is one small-cap stock after releasing a disappointing trading update. Could now be the right time to buy it for the long term?

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Challenging conditions

Reporting on Wednesday was toy company Character Group (LSE: CCT). It announced that trading conditions in its markets remain challenging. Its international sales have been adversely affected by a number of factors. Some of the world’s largest toy companies have entered Chapter 11 bankruptcy protection in the US and Canada and this has had repercussions across global toy markets. In addition, many of the company’s international customers have taken a conservative approach to purchases.

As a result of its difficult trading conditions, the company’s performance for the full year is expected to be significantly below market expectations. However, the company anticipates that it will be a temporary downturn and it’s confident of an improved performance in the latter part of the year. It’s also set to introduce new products which it believes could help to offset some of the challenges it faces.

With the company continuing to be cash flow positive and maintaining its progressive dividend policy, today’s share price fall may be somewhat excessive. The fundamentals of the business remain sound and, should trading conditions improve, it’s likely to post impressive returns. For now, though, it may be prudent to wait for evidence of improved financial figures before buying.

Solid performance

While Character Group is facing a difficult outlook, WH Smith (LSE: SMWH) continues to deliver solid and sustainable growth. In the last four years it has been able to report a rise in earnings each year, while its performance over the medium term is set to be equally upbeat. It’s forecast to record a rise in its bottom line of 7% per annum over the next two years. And, while it has a relatively high price-to-earnings (P/E) ratio of 20, its growth potential remains impressive.

That’s especially the case in its Travel business with the company continuing to expand its store estate in international markets. This not only allows it to capitalise on strong growth rates outside of the UK, it also means the business is becoming more diversified.

Certainly, there are risks to the company in the form of a slowdown in consumer spending in the UK. However, with the company’s high street business set to benefit from cost-cutting and margin improvements in future, now could be the right time to buy the stock for the long run.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended WH Smith. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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