In this article, we will look at the 8 Most Profitable Small-Cap Stocks To Invest In.
Fed’s rate cuts have been all the rage recently, and they may have set the stage for a strong Q4. On September 27, Jay Woods, chief global strategist at Freedom Capital Markets and long-term member of the New York Stock Exchange, filled in for Michael Reinking on Market Storylines inside the Icehouse Podcast feed to discuss the Fed rate cuts and outlook for Q4 2024. He said the market has absorbed rate cuts very positively, with the S&P 500 reaching new all-time highs.
He also said that historically, the fourth quarter tends to perform well when markets hit new highs in September. This holds especially true in election years. With the stock market now in Q4, Woods highlighted that certain sectors, like utilities, real estate, and industrials, led the market in Q3. Technology, however, lagged in Q3 and might make a comeback in Q4.
Small-Cap Stocks Set for Major Gains
We recently discussed the potential future outlook of small-cap stocks in an article on 8 Penny Stocks with Biggest Upside Potential According to Analysts. Here is an excerpt from the article:
On October 4, Eduardo Lecubarri, managing director and global head of small and mid-cap equity strategy at J.P. Morgan, talked about the potential of investing in small to mid-cap stocks in an interview on CNBC. He breaks down the opportunities in the space, while shedding light on how to pick the right stocks in what he calls a “generational opportunity.” He says that we are living in a tricky world where the opportunity to invest lies in realizing the hidden value in the small and mid-cap sectors and picking the right stocks instead of investing broadly.
He claims that times have changed, with small and mid-caps stocks going from being not the most suitable investment in previous years to paving the way for the biggest opportunity in the sector in the past 2-3 decades. He further elaborated and said that the opportunity of picking a small to mid-cap versus large-cap stock is bigger now than he has ever seen in the past 30 years. This generational opportunity, however, is not without its pitfalls for those who fail to make the right picks.
Pricing power and high-margin businesses can be suitable indicators of the right small to mid-cap stocks to invest in, according to Lecubarri. The need to find value and invest in stocks with achievable earnings growth expectations also holds pivotal value in making the right choices. While 2022 to 2023 was the time to stay away from small to mid-cap stocks, Eduardo Lecubarri says that times have changed with the stabilizing economy.
Analysts are thus bullish on the potential of small caps, with the general expectation that they might outperform large caps in a slowing economy. However, with the US Presidential elections just around the corner, the market environment is posing some choppiness, which demands caution from investors.
Why Are Analysts Keeping an Eye on Small Caps?
On October 4, Larry Adam, chief investment officer at Raymond James, joins CNBC’s ‘The Exchange’ to discuss why he’s keeping an eye on small caps in certain sectors. He said that lower interest rates are expected to benefit small caps, especially the Russell 2000, thus promoting the perspective that the bull market will continue. With the risk of recession now overruled, the economy is moving closer to soft landing. Adam concludes that with the Fed continuing to lower interest rates, small cap stocks will be better positioned to meet their financial needs.
These stocks get around 56% of their financing from the short end of the yield curve, which refers to the short-term interest rate on the yield curve. This typically represents the yields on bonds with shorter maturities, such as 2-year or 5-year Treasury notes. Large-cap companies, in contrast, get only 26% of their financing from these short ends of the curve. Small-caps are thus in a better position to benefit.
The Fed is anticipated to cut rates two times in 2024 and another four times in 2025, reflecting a positive market for small-caps. These stocks have also outperformed large caps. When taken in a historical context, circumstances help small caps significantly more than the rest of the market whenever the economy goes towards a soft landing.
Small Caps and a Late Cycle Economy
On October 11, CNBC’s Mike Santoli and Northwestern Mutuals’ Brent Schutte, appeared on ‘Power Lunch.’ He said that there is a delicate balancing act that the Fed has to navigate, and historically, haven’t done a good job doing so. They tend to wait till the labor market shows signs of weakening, and unfortunately, it tends to trend and then its too late. He says that this time is a little different because there is inflation and the embers are burning, and this is a late cycle economy.
With the late cycle phase of the economy, concerns about the shift from large cap stocks to small caps is rising. Schutte says that such concerns were also heard in 1999 and 2000, years that had a similar market. The market became very narrow because the economy became very narrow.
He says that one way or the other, for investors more interested in returns over a three to five year period, small and mid caps stocks, irrespective of whether a soft landing appears or not, offer value because they have been priced, somewhat, for a recession.
With that context for small and mid caps, let’s look at the 8 most profitable small-caps to invest in.
8 Most Profitable Small-Cap Stocks To Invest In
Our Methodology
For this article, we used Finviz and Yahoo Finance stock screeners plus online rankings to compile an initial list of the 60 largest small-caps. We define small-cap stock to be those with market caps between $300 million and around $2 billion. Please note that the market caps were recorded on 17th October, 2024. From that list, we narrowed our choices to 8 stocks with positive TTM net income and 5-year net income growth informed by reputable sources, including SeekingAlpha and Yahoo Finance. We then sorted the stocks in ascending order of their hedge fund sentiment, which was taken from our 912 elite hedge funds database as of Q2 of 2024.
Why do we care about what hedge funds do? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
8 Most Profitable Small-Cap Stocks To Invest In
8. Sixth Street Specialty Lending Inc. (NYSE:TSLX)
Market Cap: $1.94 billion
5-year Net Income Growth: 8.83%
TTM Net Income: $210.9 million
Number of Hedge Fund Holders as of Q2 2024: 12
Sixth Street Specialty Lending (NYSE:TSLX) is a specialty finance company that lends to middle-market companies, generating current income primarily in United States-domiciled middle-market companies. It does so through direct originations of senior secured loans and, less commonly, originations of mezzanine and unsecured loans and investments in equity securities, corporate bonds, and other instruments.
Its funding and commitments in Q2 2024 reached $164 million and $231 million, respectively, across five existing and eight new portfolio companies. The company is continually benefiting from a size and scale of six used capital bases, participating in several large-cap transactions in the quarter. This highlights the power of the platform, allowing it to toggle between small and large-cap opportunities depending on where the risk-reward and relative value are appropriate for its shareholders.
In addition, Sixth Street Specialty Lending (NYSE:TSLX) has maintained a steady deployment pace, diversifying its portfolio through higher competition periods for lower deal activity. It is continuously sourcing new investment opportunities, with 83% of total funding of new portfolio companies.
The company’s largest funding this quarter was in a senior secured credit facility to merit software holdings, reflecting its core competency in the middle market. It is positioned to be a solutions provider for significant companies, with its expertise in niche markets allowing it to move quickly and with certainty to finance its best-in-class SMB vertical market software businesses. It ranks eighth on our list of the 8 most profitable small-cap stocks to invest in.
7. Enterprise Financial Services Corporation (NASDAQ:EFSC)
Market Cap: $1.99 billion
5-year Net Income Growth: 16.77%
TTM Net Income: $171.29 million
Number of Hedge Fund Holders as of Q2 2024: 13
Enterprise Financial Services Corp (NASDAQ:EFSC) is a financial holding company for Enterprise Bank & Trust, a full-service financial institution that offers wealth management and banking services to corporate customers and individuals. It offers an array of personal and business banking services, with its lending services covering commercial real estate, commercial and industrial, residential real estate, real estate construction and development, small business administration, consumer and other loan products.
Enterprise Financial Services Corp’s (NASDAQ:EFSC) business model, management team, and associate base have been constructed to perform appropriately in any economic environment, with its Q2 2024 results being the product of years of development.
In the quarter, it expanded its margin, grew net interest income, experienced positive operating leverage, and continued to significantly compound tangible book value per share. The company has been working for the last several years to diversify its business model so it does not have to depend on one business, asset class, or market to produce high-quality and predictable earnings. Its Q2 results are the product of this strategy.
Net income reached $45.4 million for the quarter, or $1.19 per diluted share. Net interest income increased by $2.8 million to $140.5 million. Enterprise Financial Services Corp (NASDAQ:EFSC) has managed to hold this number at or around $140 million for the last six quarters despite challenging interest rate conditions. This highlights its strength, positioning it to produce high-quality earnings that continuously improve shareholder value through deep-rooted client relations.
6. Central Garden & Pet Company (NASDAQ:CENT)
Market Cap: $2.1 billion
5-year Net Income Growth: 7.52%
TTM Net Income: $144.98 million
Number of Hedge Fund Holders as of Q2 2024: 20
Central Garden & Pet Company (NASDAQ:CENT) engages in the garden and pet industries in the US, with its operations divided into two segments: Pet and Garden. Despite a challenging environment, the company delivered solid Q3 2024 earnings. It experienced double digital e-commerce growth across its garden and pet categories, and even expanded its gross margin.
Central Garden & Pet Company’s (NASDAQ:CENT) strategy to enhance efficiency and simplify its business across its organization is bearing fruit. It is maintaining its outlook for the fiscal year, and is positioned to benefit from the long-term positive consumer trends in the pet and garden industries. Its cost and simplicity program is increasingly equipping the company to improve its profitability and make productive investment in its Central to Home strategy.
Its Pet segment sales grew by 1% to $508 million. This was driven by the recent TDBBS acquisition, its professional business, dog and cat and equine. In addition, its POS outperformed shipments. Branded pet products outperformed the company’s private label products, highlighting the strength of its brands.
It also expanded its market share in flea-and-tick aquatics, small animals, and wild birds. The company expects consumable pet products to continue growing, with household penetration and buy rates to remain fairly stable. It also anticipates consumer trends, pet health and wellness, a growing share of e-commerce, and a shift to younger generations to support the long-term growth of the pet industry. Central Garden & Pet Company (NASDAQ:CENT) ranks sixth on our list of the 8 most profitable small-cap stocks to invest in.
5. Pathward Financial Inc. (NASDAQ:CASH)
Market Cap: $1.85 billion
5-year Net Income Growth: 14.82%
TTM Net Income: $168.95 million
Number of Hedge Fund Holders as of Q2 2024: 21
Pathward Financial (NASDAQ:CASH) is a financial holding company with Pathward, National Association (the Bank) as its subsidiary. The Bank’s operations are divided into three segments: Commercial, Consumer, and Corporate Services/Other.
Its financial results for the first nine months of 2024 were very promising, and the company is continuing to execute its goals. It is delivering solid financial results with a focus on balance sheet management, led by the continuous evolution of its product offerings and risk-adjusted returns. Net income reached $41.8 million for Q2, with earnings per diluted share standing at $1.66. These results were driven by a 14% increase in net interest income compared to the same quarter in 2023.
Pathward Financial’s (NASDAQ:CASH) focus on the asset side of the balance sheet is on optimizing assets, sourcing and underwriting loans that have the highest risk-adjusted returns with discipline. It is also continually seeing a robust pipeline in government-guaranteed loans and working capital, both SBA and USDA. The company recently put in a new technology system to create efficiencies through the underwriting process and offers improved asset management capabilities that help maximize its efforts while slashing costs.
It is also seeing solid originations in consumer lending, and is continuing to co-innovate. The company expects to launch additional products and add partners in the future, allowing its partners to thrive and the company to grow. It takes the fifth spot on our list of the most profitable small cap stocks to invest in.
4. Huron Consulting Group Inc. (NASDAQ:HURN)
Market Cap: $1.90 billion
5-year Net Income Growth: 25.83%
TTM Net Income: $79.84 million
Number of Hedge Fund Holders as of Q2 2024: 23
Huron Consulting Group (NASDAQ:HURN) is a professional services company that operates in three segments: Education, Healthcare, and Commercial. The company is running on strong fundamentals and has experienced solid second-quarter growth driven by its Healthcare and Education segments.
It expanded its adjusted EBITDA margin to 15%, with its adjusted earnings per share also expanding to a record 20% higher than the previous high watermark set in Q3 2023. It generated record cash flow in Q2 2024, allowing the company to meaningfully reduce its debt and return capital to shareholders through ongoing share repurchases. Its record Q2 performance capped a solid first-half 2024 performance.
These results highlight a strong execution strategy along with the positive impact and changes made to its enterprise operating model at the outset of 2022. These changes have expanded the set of offerings the company delivers to its core industry clients, allowing it to operate its business at improved efficiency levels.
Huron Consulting Group’s (NASDAQ:HURN) strategic focus lies on driving sustainable revenue growth, effectively deploying capital, and expanding margins to deliver superior returns for its shareholders. The company’s earning power has improved, primarily due to the scaling of its business over the past three years, the build-out of its global delivery capacity, and enhanced focus on key operating levers like utilization and pricing.
3. Donnelley Financial Solutions Inc. (NYSE:DFIN)
Market Cap: $1.92 billion
5-year Net Income Growth: 11.02%
TTM Net Income: $106.1 million
Number of Hedge Fund Holders as of Q2 2024: 24
Donnelley Financial Solutions Inc. (NYSE:DFIN) provides software and technology-enabled financial regulatory and compliance solutions. It offers regulatory filing and deal solutions through its technology-enabled services, software, and print and distribution solutions.
Donnelley Financial Solutions (NYSE:DFIN) showed improved revenue performance in its Q2 2024 results, with record adjusted EBITDA margin and quarterly adjusted EBITDA and increases in both free cash flow and operating cash flow. This improved performance highlights the company’s continued progress in its transformation, positioning it to achieve its long-term financial targets.
The company is continually making progress against its long-term objectives. It is transforming DFIN into a solution-centric company often delivered by software, with software solutions net sales increasing 14.4% on an organic basis year over year. This shows a continuation of the strong growth rate it attained in Q1 of 2024. The Q2 software solutions net sales growth continues to be driven by the performance of Venue, its virtual data room product. It posted approximately 38% sales growth, reflecting a strong sales execution across Venue’s broad application within the M&A ecosystem serving both private and public companies.
The growth rates of ActiveDisclosure and Arc Suite, which are Donnelley Financial Solutions’ (NYSE:DFIN) recurring compliance software products, also showed positive signs in Q2 and are set to improve in the second half of 2024. Improvement for ActiveDisclosure is driven by recent wins along with overlapping 2023’s platform transition. The improved growth rate for Arc Suite is primarily driven by the tailwind from the Tailored Shareholder Reports regulation. Donnelley Financial Solutions (NYSE:DFIN) ranks third on our list of the 8 most profitable small-cap stocks to invest in.
2. CONMED Corporation (NASDAQ:CNMD)
Market Cap: $2.01 billion
5-year Net Income Growth: 28.45%
TTM Net Income: $98.59 million
Number of Hedge Fund Holders as of Q2 2024: 25
CONMED Corp (NASDAQ:CNMD) is a medical technology company that provides surgical devices and equipment for minimally invasive procedures. Healthcare professionals, such as surgeons, use its products in a range of specialties, such as general surgery, orthopedics, thoracic surgery, gynecology, and gastroenterology.
The company’s product line comprises general surgery and orthopedic surgery. General surgery comprises endo-mechanical instrumentation primarily used for minimally invasive gastrointestinal and laparoscopic procedures. The orthopedic surgery product line comprises lower extremities, sports medicine implants and instrumentation, specialty-powered surgical instruments, and more.
CONMED Corp (NASDAQ:CNMD) has a strong operational model, with total sales for Q2 2024 reaching $332 million. This represents a 4.5% growth as reported and 5.2% in constant currency. This performance delivered record-high quarterly sales results in line with the company’s range of expectations.
After its first full quarter in the market, the company’s US AirSeal capital unit sales grew faster than in the prior year’s quarter, with no slowdown in Airseal capital. The company’s total sales increased 5.2% in Q2, with sales in the US growing by 6.1% as compared to the prior year’s quarter and international sales increasing by 4.0%.
In addition, the company’s worldwide general surgery revenue also increased by 9.4% in the quarter, with US general surgery growing by 8.9% and international general surgery revenue increasing by 10.5%. Its surgery side of the business is thus healthy and performing in line with its historical trends. The numbers demonstrate a healthy growth company with the potential to grow in the future. It takes the second spot on our list of the 8 most profitable small-cap stocks to invest in.
1. MYR Group Inc. (NASDAQ:MYRG)
Market Cap: $2.03 billion
5-year Net Income Growth: 8.21%
TTM Net Income: $49.22 million
Number of Hedge Fund Holders as of Q2 2024: 27
MYR Group (NASDAQ:MYRG) is a holding company that operates through its subsidiaries and provides specialty electrical construction services for the industrial and commercial construction markets and electric utility infrastructure. Its operations are divided into two segments: Transmission and Distribution (T&D) and Commercial and Industrial (C&I).
The company’s Q2 2024 results were impacted by its T&D segment due to clean energy projects scheduled to complete mechanical by the end of 2024. In addition, one project within the company’s C&I segment also had an effect, as it is scheduled to reach substantial completion during Q4 2024.
However, project execution across its business segment remains strong, with a healthy bidding activity. MYR Group (NASDAQ:MYRG) is strategically expanding on existing partnerships and capturing new opportunities throughout markets for continued long-term growth. The growing demand for data centers boosted by the increasing prominence of artificial intelligence is continually offering exciting growth opportunities for the company’s business now and in the coming future.
Its strong customer relationship and breadth of capabilities strategically position it to win contracts for new data center work and help erect the electrical infrastructure necessary to power these facilities. In Q2 2024, in the company’s C&I segment, Western Pacific Enterprises was awarded a Canadian transportation project valued at around $170 million, substantially solidifying its long-standing regional working relationships.
Overall, MYRG ranks first among the 8 most profitable small-cap stocks to invest in. While we acknowledge the potential of small-cap stocks, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than MYRG but trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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