We recently made a list of 10 Best NASDAQ Stocks Under $20 to Buy. In this piece, we will look at where R1 RCM Inc. (NASDAQ:RCM) 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.
R1 RCM Inc. (NASDAQ:RCM)
Number of Hedge Fund Holders In Q2 2024: 42
Share Price: $14.17
R1 RCM Inc. (NASDAQ:RCM) is a specialty business services provider that caters to the needs of the healthcare industry. The firm allows hospitals and other similar establishments to manage their billings and revenue collections and stay up to date with regulatory compliance. Its stock is up 31% year to date, primarily due to the fact that the firm is being taken private by its investors. After R1 RCM Inc. (NASDAQ:RCM)’s SEC filings revealed investor willingness for a deal in February, the stock soared by 31%. The shares added another 9.7% in August after the firm announced that it had entered into an acquisition agreement that would take it private for $14.30 per share. Consequently, R1 RCM Inc. (NASDAQ:RCM)’s stock hinges on the success of this deal, and if there are any hurdles, then the shares could struggle. On the business model front, since R1 RCM Inc. (NASDAQ:RCM) is a revenue cycle management company, it stands to benefit from the introduction of AI into its offering and a stable, margin heavy business with stable recurring revenue. However, the firm has sizeable long term debt of $2.2 billion which can hamper its growth by reducing cash flow.
Voss Capital mentioned R1 RCM Inc. (NASDAQ:RCM) in its Q1 2024 investor letter. Here is what the fund said:
“Just as we hit send on the Q4 letter, R1 received a non-binding buyout offer from its largest shareholder, private equity firm New Mountain Capital (32.3% ownership). At first the Board encouraged New Mountain to collaborate with the second largest holder, TowerBrook Capital (29.5% ownership), as they knew TowerBrook would likely not be a seller at such a low-ball valuation (minority shareholder “squeeze outs” by existing PE owners are a recurring theme this year). R1’s board then backtracked eight days later and put New Mountain in timeout and hired both Barclays and Qatalyst Partners (a boutique M&A firm with stellar reputation of getting tech companies sold) to run a full auction process. We did not sell any RCM on the initial pop (thinking it to be a more stable merger-arb type situation) and unfortunately rode the stock all the way back down to its pre-deal announcement price. We think the market is underestimating the probability of a higher buyout offer, even if it is from New Mountain and TowerBrook and the gains will quickly be recouped. If there is no deal, we believe the upside will be much greater over the next few years as R1 continues to execute and on-board large customers and reduce costs using AI. Our base case price target moves down to $16 if a deal is commenced and remains $28 (133% upside) over the next 2-3 years if there is no buyout. This is based on 14x 2026 adjusted EBIT (EBITDA-Capex), or 12x Q4 2026 EBIT run-rate, a large discount to comps.”
Overall RCM ranks 7th on our list of the best NASDAQ stocks under $20. While we acknowledge the potential of RCM 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 RCM but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published on Insider Monkey. All investment decisions should be made after consulting a qualified professional.
