We recently made a list of 10 Best NASDAQ Stocks Under $20 to Buy. In this piece, we will look at where American Airlines Group Inc. (NASDAQ:AAL) ranks among the list of the best NASDAQ stocks under $20.
The close of September has seen the much awaited interest rate cut from the Federal Reserve materialize. The Fed, in a move that surprised some market participants, decided to cut rates by 50 basis points in the third week of September. Investors’ surprise surrounding this decision was clear as major indexes fell in the immediate aftermath of the rate cut and ended the day lower. This was because an outsized rate cut stoked fears about the health of the economy, which tends to make the US dollar stronger and hurt equity returns.
However, the next day would see a complete reversal. Bullish investors made sure that the benchmark S&P stock index closed at a new record high – its first in two months which has seen investors reckon with a weak labor market to contend whether it signaled an incoming recession. The day after the rate cut, the benchmark S&P index gained 1.70% and closed the day at a new record of 5,713 points.
However, its percentage gains during the day would be eclipsed by the broader NASDAQ stock index, as it was up by 2.61%. The week’s end would see the S&P, the NASDAQ, and the Dow close with 1.36%, 1.49%, and 1.62%, respectively. Yet, even though indexes closed higher in a month that is typically bearish for stocks, Friday’s trading saw the NASDAQ trim 0.36% over the previous day while the S&P ended 0.19% lower.
This end of the week uncertainty underpins the sentiment that should mark stock returns for October. In October, investors will reckon with a hotly contested election and try to decipher whether the third quarter earnings season makes stocks more attractive. With the benchmark S&P trading at a forward price to earnings ratio of 21 which is 34% higher than its long term average of 15.7, there appears to be limited room for further gains in equities unless the corporate sector smashes earnings out of the park. This overvaluation in markets is also evident in the price to book value ratio, as equities are currently trading at 5x, which is nearly double their long term average of 2.6x.
Consequently, the bullishness that investors have had prior to the interest rate cutting cycle makes us wonder whether large cap stocks can deliver more returns. The technology sector as a whole has been led by the world’s leading artificial intelligence graphics processing unit (AI GPU) designer whose shares are up 141% year to date. Yet, the uneasiness that investors are feeling is apparent as well. This same stock had gained 181% by the second week of June, with concerns of a product delay, weaker margins, and tepid guidance making it pull back and lose 27% by the first week of August which also greeted investors with weak labor market data.
Its gains have also pushed the broader NASDAQ index in 2024 which is up by 22.74% year to date. Using a NASDAQ ETF by Fidelity as a proxy, we find out that the top five stocks in the ETF account for roughly 44% of the total holdings. These five stocks, starting from the fifth, are up by 62%, 27.8%, 141%, 17.36%, and 22.9%. This makes it clear that the biggest holdings of the index have driven its returns.
This bifurcation in the stock market has been on the minds of investment banks as well. As we noted in our coverage of Morgan Stanley’s Highest Conviction Stocks: Top 20 Stocks To Buy, the banks’ analysts had noted that there “is ample room for equities performance to broaden, but this requires a cyclical recovery,” adding that the market cap based difference in the benchmark S&P’s returns was clear as the forward P/E “runs at 21x on a cap-weighted basis but only 16x equal- weighted.” However, they cautioned that the potential to benefit from this gap via investing in small cap stocks “requires economic growth acceleration with lower interest rates, which seems unlikely in the current inflation environment.”
This return has fluctuated with bond yields in the past. Data compiled by MS shows that historically at 1% levels for bond yields, small cap stocks returned 100% relative to large caps. On the flip side, as yields soared to ~5.6%, this metric dropped to 82%.
Yet, even though MS might have been cautious for small caps before the Fed’s interest rate cut, the undervaluation in small caps is supported by other data points too. For instance, JPMorgan shares that for small and medium cap (SMID) and large cap stocks that are the top 20% in terms of free cash flow margins, the forward P/E ratio of the SMID stocks relative to the large cap stocks was 0.74x as of April 2024. This marks a sizeable difference over its peak of 1.38x in April 2009. Similarly, if we consider the forward P/E ratios of small cap over large cap stocks as a whole, we find out that as of May 2024, they were trading at 73%, which is quite low over a high of approximately 125% after 2010.
Cycling back to MS’ belief that small cap stock performance is dependent on the economy, data shows that as the economy recovers from a recession, small caps delivered 9.62% in returns historically starting from 1984. This is 0.66% higher than the large cap returns of 8.97%, and the gap widens during economic expansion. In this phase of the business cycle, small caps delivered 25.5% in returns, while the large cap returns were 20.57%. Similarly, extrapolating this analysis to the Fed’s rate cut cycles by running a regression with the small to large cap returns as a function of rate changes shows that the rate changes have a beta of -4.39. This means that reducing rates leads to a higher spread and indicates that lower rates do prime up small caps for gains provided that economic performance is robust.
Our Methodology
To make our list of the best NASDAQ stocks under $20 to buy, we ranked the 100 most valuable stocks on the NASDAQ that had a share price lower than $20 by their market capitalization and picked out the stocks with the highest number of hedge fund investors in Q2 2024.
Why are we interested in the stocks that hedge funds pile into? 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).
A broker in a trading room surrounded by screens, representing the stock market.
American Airlines Group Inc. (NASDAQ:AAL)
Number of Hedge Fund Holders In Q2 2024: 38
Share Price: $11.41
American Airlines Group Inc. (NASDAQ:AAL) is a sizeable US airline with more than 900 aircraft in its fleet. It is one of the younger airlines in the industry, and recent turmoil has placed the firm and its stock on the back foot. American Airlines Group Inc. (NASDAQ:AAL)’s shares are down 15.4% year to date, on the back of a 15% drop in May. This was due to disappointing second quarter guidance which saw the airline cut earnings outlook to $1 – $1.15 per share and increase the revenue drop outlook to 5% to 6%. This has stemmed from a lot of headaches at the firm after a strategic misstep saw it try to modernize fare distribution by introducing a new system, reducing sales staff, and eliminating several travel agents from its frequent flyer program. Naturally, this has created headwinds for the firm as it enters into the second half where increased holiday travel demand allows airlines to increase their fares. Consequently, American Airlines Group Inc. (NASDAQ:AAL) might continue to face trouble unless it can regain market share and set prices that are more in line with competitors.
American Airlines Group Inc. (NASDAQ:AAL)’s management reversed course on several of its strategies and commented on the decision during the Q2 2024 earnings call:
“With regard to our commercial organization, we immediately took action and changed senior leadership. Steve, our vice chair, second in command, and most seasoned and accomplished executive has taken charge of our commercial efforts, reorganized the team, completed a deep dive on issues and opportunities, and laid out a recovery plan that we are executing on quickly. We have also strengthened our revenue forecasting processes. Our near-term actions are concentrated on winning back customers in our share of revenue in agency and business channels. To that end, in June, we reinstated fares in the distribution channel traditionally used by travel agencies and corporate managed travel programs. Approximately $14 billion of our annual revenue was booked through this system in 2023.
This action ensures our product is available wherever customers want to buy it, and removes the most objected-to pain point of our previous distribution strategy. Next, we engaged our large TMC partners to put in place new incentive-based agreements to restore our share in those channels. Those efforts have been well-received, and we are having good conversations with companies including Amex GDP, with which we have a longstanding relationship. We expect agreements with TMC soon, and we will then work to reengage the broader business and leisure agency community. Additionally, we have eliminated plans to differentiate how customers earn miles based on where they book their travel, removing another significant obstacle impacting booking behavior and business relationships.”
Overall AAL ranks 9th on our list of the best NASDAQ stocks under $20. While we acknowledge the potential of AAL as an investment, our conviction lies in the belief that some 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 AAL but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
READ NEXT: $30 Trillion Opportunity: 15 Best Humanoid Robot Stocks to Buy According to Morgan Stanley and Jim Cramer Says NVIDIA ‘Has Become A Wasteland’.
Disclosure: None. This article was originally published on Insider Monkey. All investment decisions should be made after consulting a qualified professional.