We recently published a list of 8 Most Undervalued Small-Cap Stocks To Buy According To Analysts. In this article, we are going to take a look at where Valaris Ltd. (NYSE:VAL) stands against the other most undervalued small-cap stocks to buy according to analysts.

Is a Multi-Year Small-Cap Cycle Ahead?

The landscape for small and mid-cap companies is becoming increasingly exciting in light of the Fed’s recent rate cuts, which could unlock significant investment opportunities. While the Russell 2000 index has lagged behind larger averages, analysts are optimistic about the growth potential of these stocks as market conditions improve.

Many small and mid-cap companies are well-positioned to capitalize on the favorable economic environment, with innovative strategies and strong fundamentals that can drive demand and market share. As interest rates stabilize and investor confidence grows, these companies are likely to attract renewed attention from investors seeking high-growth opportunities.

With the current environment ripe for exploration, there has never been a better time for investors to consider small and mid-cap stocks. Such was the sentiment of Curtis Nagel, senior US SMid cap internet analyst at BofA Securities, who spoke on this market scenario on CNBC earlier. We covered his opinion in another one of our articles, 7 Best Small Company Stocks To Invest In. Here’s an excerpt from it:

“…he believes this could spell big opportunities for SMID-cap stocks across various sectors, including home furnishings and subscription services.

Nagel specifically pointed out Restoration Hardware, noting that it is a household name that often flies under the radar… Nagel’s overall thesis focuses on updating price targets for companies with high sensitivity to interest rates and strong prospects for revenue and earnings growth in a soft landing scenario. ACV Auctions was highlighted as an intriguing opportunity. Nagel described it as a digital marketplace for wholesale vehicles where dealerships trade cars. He noted that this market has not been fully digitized yet, placing the company at the forefront of this transition. Although the wholesale vehicle market has faced challenges, down about 25% relative to historic averages, Nagel theorized that as interest rates improve and car affordability increases, the company could see a market rebound. He views this stock as potentially overlooked but having significant upside.”

In an interview on CNBC on September 30, Nancy Prial, Co-CEO & Senior Portfolio Manager at Essex Investment Management, expressed that she expects small-cap stocks to grow, driven by rate cuts and stock-picking opportunities.

Prial noted that small caps have been outperforming in the third quarter, largely driven by expectations of rate cuts, with a 50 basis point reduction being more significant than previously anticipated. She expressed optimism that small caps have substantial room to grow, emphasizing that this could mark the beginning of a multi-year cycle for these stocks. Currently, small-cap stocks are underrepresented in the market, comprising just under 5% of the total equity market, which is at record lows. This low ownership level presents an attractive opportunity for investors.

She pointed out that small-cap stocks remain significantly undervalued compared to their larger counterparts. Prial argued that for small caps to gain traction, several conditions must be met: the continuation of rate cuts, confidence in navigating a soft landing rather than a recession and expanding relative earnings growth. She noted that relative earnings growth for small caps is starting to improve and is expected to surpass that of large caps by the end of the year.

When asked about overall market estimates, Prial acknowledged that while the S&P 500 is projected to see earnings growth of 13% in the fourth quarter and 15% in 2025, she believes small caps could exceed these figures. Despite a slight slowdown in economic growth, she maintained that small-cap stocks could achieve earnings growth rates between 15% and 20% next year. She cautioned, however, that overall indices might not reflect this growth as estimates often start high before being revised downward.

Prial also discussed her investment picks related to infrastructure and near-shoring, specifically mentioning Clean Harbors. While acknowledging its strong performance in Q3, she clarified that they do not expect new legislation from Washington to drive further gains. Instead, she believes companies like this will benefit from existing bills that are now being implemented. Additionally, she highlighted Arcosa as a “picks and shovels” play within the sector, emphasizing its role in supporting the build-out of artificial intelligence infrastructure and digitalization efforts across various industries.

Her insights reflect a bullish outlook on small-cap stocks amid changing economic conditions and anticipated monetary policy shifts. By focusing on strategic stock selection and recognizing the potential for earnings growth within this sector, investors may find compelling opportunities as they navigate the evolving market landscape.

Methodology

We used stock screeners to look for companies trading between $1 billion and $10 billion, that’s our definition of small-cap stocks. We then found 25 stocks with a forward price-to-earnings ratio under 15, and an upside potential of over 20%. We then selected the 8 stocks that were the most popular among elite hedge funds and that analysts were bullish on. The stocks are ranked in ascending order of their analysts’ upside potential.

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).

Valaris Ltd. (NYSE:VAL)

Forward Price-to-Earnings Ratio: 5.41

Average Upside Potential: 60.97%

Number of Hedge Fund Holders: 39

Valaris Ltd. (NYSE:VAL) is the largest offshore drilling and well drilling company in the world, and owns 52 rigs, including 36 offshore jack-up rigs, 11 drillships, and 5 semi-submersible platform drilling rigs. It owns and operates a fleet of drilling rigs, including semi-submersibles and drillships, which are used to explore and develop oil and gas fields in deepwater and harsh environments.

The broader energy sector has faced challenges due to global economic concerns and rising interest rates. Slowing economic growth has led to decreased oil demand. This, combined with lower oil prices, has negatively impacted Valaris Ltd. (NYSE:VAL), as it relies on drilling rig demand from oil producers. Reduced spending on exploration and drilling activities has made it difficult for the company to achieve higher revenue and earnings growth.

Yet, the company continues to record booming business, securing a $500 million contract backlog with Equinor offshore Brazil for Valaris DS-17. In the second quarter of 2024, it made $610.10 million in revenue, up 46.94% year-over-year. This growth was driven by a 99% revenue efficiency rate during the quarter, reflecting effective contract management and optimal utilization of its fleet. The company’s backlog also increased for the 7th consecutive quarter, reaching over $4.3 billion.

The company has achieved several safety milestones, including 2 years without a recordable incident for the Valaris 249 team and 1 year without a recordable incident for the Valaris DS-10 and 106 teams. It has also successfully reactivated the Valaris DS-7 drillship for a long-term contract, demonstrating its ability to efficiently reactivate rigs and secure profitable contracts. It still has additional high-specification drillships that can be reactivated to meet increasing customer demand.

It’s a promising investment opportunity in the offshore drilling industry. The company’s strong financial position, growing backlog, and focus on reactivating high-specification rigs position it for continued growth and profitability. With stable oil prices and positive industry trends, Valaris Ltd. (NYSE:VAL) is well-equipped to capitalize on emerging opportunities and deliver value to shareholders.

Praetorian Capital stated the following regarding Valaris Limited (NYSE:VAL) in its Q2 2024 investor letter:

“Valaris Limited (NYSE:VAL) has been rangebound for over two years now, awaiting the signing of new contracts at current market rates, that will replace expiring contracts that are frequently less than half of current prevailing rates. There have been some questions as to why the company has been slow to sign new contracts. However, I believe that management is trying to trade a slightly reduced price for increased duration of contract tenure, and that’s the reason for a lack of commentary on new contracts. Should the company announce new contracts at anywhere near current market rates, I believe that the shares will respond in a rather dramatic way—especially as Valaris is by far the cheapest of the large drilling companies (based on the enterprise value per rig metric), despite having one of the best fleets and strongest balance sheets. Between our common and warrant position, Valaris was our 2nd largest position at the end of June.”

Overall VAL ranks 1st on our list of most undervalued small-cap stocks to buy according to analysts. While we acknowledge the growth potential of VAL as an investment, our conviction lies in the belief that AI stocks hold great promise for delivering high returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than VAL 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 is originally published at Insider Monkey.