In this article, we will discuss the 7 Small-cap Stocks to Invest In.
The market experts opine that strong and stable earnings growth, a favourable valuation environment and the expectation of lower interest rates provide a supportive environment for global small-cap equities. American Century Investments believes that after the outperformance by large-cap stocks, the investors saw a notable rotation toward small-caps in the month of July. That being said, after the early August volatility, investors still wonder whether or not the small-cap stocks are well-placed to sustain through the rest of the year and in 2025.
Tailwinds for Small-Cap Stocks
The US small-cap stocks continue to show signs of renewed momentum, hinting at a shift in performance leadership. Janus Henderson Investors believes that, from mid-July to August end, the Russell 2000 Index outperformed the large-cap indices and the “Magnificent Seven” stocks. The global small-cap stocks have experienced the impact of increased inflation, higher interest rates, and a slowdown in economic growth over the previous 3 years. The sharp increase in rates beginning in 2022 supported in driving a rotation out of small-caps and into large-caps. Therefore, small-cap growth stocks were the ones that particularly saw the brunt.
Despite economic uncertainty, American Century Investments believes that inflation seems to be moving in the right direction, and central banks have started to cut rates. The US Fed’s approach remains more cautious than the expectations. However, with rates expected to decline further, investors are expected to benefit from an environment of moderate economic growth and lower inflation. The investment firm believes that this environment will be conducive to risk-taking and a tailwind for small-caps.
Such a pivot is expected to enable investors to shift focus from central bank policy to corporate profits. This will help create a more favorable environment for active security selection. Over the long term, the investors are expected to be inclined to the companies having improved earnings growth. Also, Janus Henderson Investors believes that small caps have delivered strong performance historically when their market cap as a % of the total market declines below 5%. This threshold was recently crossed.
Valuation Gap Provides Further Opportunity
The extended period of large-cap dominance resulted in the significant widening of the valuation gap between small-cap and large-cap stocks, as per Janus Henderson Investors. The relative valuation of small caps compared to large caps sat at the 16th percentile (at August end). The investment firm went on to say that ever since the Russell 2000 Index was created in 1978, small caps have been this inexpensive only once.
The current valuations do impact the future returns, and current disparity provides a strong entry point. Lower inflation might disproportionally boost small caps’ earnings expansion because of their typical lower pricing power and increased labor intensity in comparison to larger counterparts.
Additionally, Janus Henderson Investors mentioned that small-cap stocks have historically outperformed large caps by ~10% during the first 12 months after an initial Fed rate cut. The firm believes that the potential return to a normalized cost of capital might fuel small-cap earnings. Therefore, when financial conditions ease, smaller companies get easy access to funding for growth.
With this in mind, we will now have a look at the Top Investors’ Stock Portfolio: 7 Small-cap Stocks to Invest In.
Stocks
Our Methodology
In order to list 7 Small-cap Stocks to Invest In, we used a Finviz screener to filter out the stocks from the small-cap space. Therefore, we chose companies having a market cap of less than $2 billion. Finally, the stocks have been arranged in ascending order of their hedge fund sentiments, as of 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).
Top Investors’ Stock Portfolio: 7 Small-cap Stocks to Invest In
7) Stewart Information Services Corporation (NYSE:STC)
Market Cap as of 9 October: $1.87 billion
Number of Hedge Fund Holders: 10
Stewart Information Services Corporation (NYSE:STC) provides title insurance and real estate transaction-related services in the US and internationally.
Despite the depressed housing market, Stewart Information Services Corporation (NYSE:STC) conveyed a strong competitive stance, thanks to its focus on operational efficiency, talent retention, and market expansion. Wall Street analysts remain optimistic about the company’s technology investments which are targeted at improving customer experience.
While Stewart Information Services Corporation (NYSE:STC) remains confident about serving the real estate market, it expects long-term margins to improve with a normalized market.
The company continues to focus on growth initiatives and margin management, with anticipations of maintaining the same margins as the previous year if the current trends continue. Moreover, market players are quite optimistic about Stewart Information Services Corporation (NYSE:STC)’s acquisition of the All New York Title Agency, Inc. This acquisition supports its focus on growing the National Commercial Services business.
Stewart Information Services Corporation (NYSE:STC) emphasized growing its commercial presence in unique sectors like Energy and Affordable Housing.
Analysts at Stephens reiterated an “Overweight” rating on the shares of Stewart Information Services Corporation (NYSE:STC), issuing a $79.00 price target on 25th July.
6) Global Net Lease, Inc. (NYSE:GNL)
Market Cap as of 9 October: $1.9 billion
Number of Hedge Fund Holders: 14
Global Net Lease, Inc. (NYSE:GNL) is a publicly traded real estate investment trust.
During the Q2 2024 earnings call, Global Net Lease, Inc. (NYSE:GNL) highlighted a series of strategic dispositions, with the total reaching $728 million and a cash cap rate of 7.3% on occupied assets. The company raised its guidance for dispositions to between $650 million – $800 million for the year. Its net debt to adjusted EBITDA ratio saw an improvement to 8.1 times, and the company’s management is confident in sustaining positive momentum in H2 2024.
Global Net Lease, Inc. (NYSE:GNL) has no debt maturing for the remainder of 2024 and it plans to continue reducing the debt balance. While the company remains focused on reducing leverage and aligning with industry peers via strategic dispositions, its management expects the multi-tenant portfolio to touch mid-90s occupancy. This should help enhance Global Net Lease, Inc. (NYSE:GNL)’s earnings potential.
The company is optimistic about its balance sheet and the net lease industry’s positive momentum. Global Net Lease, Inc. (NYSE:GNL) discussed strategies to reduce its net debt to adjusted EBITDA, which include moving assets from the credit facility to the ABS Master Trust. The company is targeting to optimize its financial position while, at the same time, maintaining a robust leasing activity.
BMO Capital Markets reaffirmed an “Outperform” rating, issuing a $11.00 target price on 28th June. As per Insider Monkey’s Q2 2024 database, Global Net Lease, Inc. (NYSE:GNL) was in the portfolio of 14 hedge funds.
5) WesBanco, Inc. (NASDAQ:WSBC)
Market Cap as of 9 October: $1.74 billion
Number of Hedge Fund Holders: 14
WesBanco, Inc. (NASDAQ:WSBC) operates as the bank holding company for WesBanco Bank, Inc. which provides retail banking, corporate banking, personal and corporate trust, and other related services to individuals and businesses in the United States.
The company recently disclosed a proposed merger with Premier Financial Corporation. This merger is expected to enhance stakeholder value with the help of significant cost synergies. Post-merger, Wall Street analysts expect improvements in net interest margin, return on average assets, and return on average tangible common equity. WesBanco, Inc. (NASDAQ:WSBC) continues to explore further merger and acquisition opportunities, primarily in the Michigan market. It is also preparing for expansion in Michigan, with an emphasis on understanding local markets and players.
WesBanco, Inc. (NASDAQ:WSBC) remains optimistic about maintaining a favorable expense run rate and it has plans for marketing investments to aid deposit gathering. The bank has been addressing the CRE loan concentration by being more selective and expects that low marks on CRE loans might rebound because of accretion.
Also, the acquisition of Premier Financial should extend WesBanco, Inc. (NASDAQ:WSBC)’s reach into Northern Ohio, a market presenting strong growth opportunities. The acquisition should create economies of scale. DA Davidson upped its price objective on shares of WesBanco, Inc. (NASDAQ:WSBC) from $35.00 to $42.00, giving a “Buy” rating on 29th July.
4) Kennametal Inc. (NYSE:KMT)
Market Cap as of 9 October: $1.95 billion
Number of Hedge Fund Holders: 23
Kennametal Inc. (NYSE:KMT) is engaged in manufacturing, purchasing, and distributing tools, tooling systems, and solutions to the metalworking, mining, oil, and energy industries.
Kennametal Inc. (NYSE:KMT) recently showcased its efforts in investment and automation, which form part of its strategy to improve efficiency and profitability amidst industry challenges. Additionally, the company continues to explore potential changes in its selling approach, which should help it enhance market penetration and customer retention.
Market experts opine that Kennametal Inc. (NYSE:KMT)’s strong emphasis on innovation and automation should translate into improved operational efficiency, reduced costs, and enhanced product quality. By making investments in cutting-edge technologies, Kennametal Inc. (NYSE:KMT) plans to differentiate itself from competitors and tap a larger market share. The focus on automation should help mitigate the impact of labor shortages and wage pressures.
Moreover, innovative products and processes should help in opening up new market opportunities or applications for Kennametal Inc. (NYSE:KMT)’s expertise in materials science and tooling. As per Wall Street, these initiatives are expected to position Kennametal Inc. (NYSE:KMT) as a leader in Industry 4.0 technologies in its sector and can potentially attract new customers and create additional revenue streams.
For FY 2025, the company expects sales of between $2.0 billion – $2.1 billion, with pricing actions likely to cover raw material costs, wages, and general inflation. It expects its adjusted EPS to be in the range of $1.30 – $1.70. Heartland Advisors, an investment management company, released its second-quarter 2024 investor letter. Here is what the fund said:
“These are companies like Kennametal Inc. (NYSE:KMT), the manufacturer of industrial cutting tools and components that we mentioned in our Q1 commentary. The company is emerging from trough demand and has seen EBITDA contract on a year-over-year basis in 5 of the last 7 quarters. But the company has been undergoing extensive self-help during the past 5 years, taking out $200 million in structural costs, cutting its headcount by 20%, and closing 6 plants as part of an extensive restructuring. The heavy lifting/investment phase seems to now be in the rearview mirror. While demand has not yet inflected higher, sales are stabilizing. If Kennametal sees even a slight pickup in demand in its end markets, that could provide an immediate and robust boost to its operating margins. Furthering our confidence, KMT’s newly appointed CEO purchased shares in the quarter and the company is active on its buyback program.”
3) RxSight, Inc. (NASDAQ:RXST)
Market Cap as of 9 October: $1.95 billion
Number of Hedge Fund Holders: 34
RxSight, Inc. (NASDAQ:RXST) is a commercial-stage medical device company, which is engaged in R&D, manufacturing, and selling of light adjustable intraocular lenses (LAL) utilized in cataract surgery.
Wall Street believes that RxSight, Inc. (NASDAQ:RXST)’s advancements, which include FDA approval for an extension of the spherical refractive power range for the LAL+, should drive commercial distribution by the end of 2024. The company remains focused on growth in the US and expansion of international regulatory approvals. It continues to capture ~50% of the premium intraocular lens market and improve penetration in existing accounts.
RxSight, Inc. (NASDAQ:RXST) sees a growing demographic of patients considering cataract surgery as a long-term opportunity. Also, positive feedback on the LAL+ lens should fuel utilization growth and contribute to LDD sales. In its recent earnings call, the company highlighted that new customers continue to adopt LAL technology faster, with strong conversion from monofocal and astigmatism correction lenses.
RxSight, Inc. (NASDAQ:RXST) aims to invest significantly in sales, marketing, and R&D in a bid to accelerate internal projects. As per Wall Street, its focus on innovation and market expansion, together with its commitment to customer satisfaction and product development, drives a positive long-term outlook. The company raised its full-year revenue guidance for 2024, which demonstrates confidence in its product offerings and market strategy. FY 2024 revenue should come in the range of $139 million – $140 million.
BTIG Research increased its price objective from $72.00 to $73.00, giving a “Buy” rating on 15th July.
2) Vestis Corporation (NYSE:VSTS)
Market Cap as of 9 October: $1.95 billion
Number of Hedge Fund Holders: 34
Vestis Corporation (NYSE:VSTS) offers uniform rentals and workplace supplies in the US and Canada.
Market experts opine that new business wins and improved customer retention rates should continue to help Vestis Corporation (NYSE:VSTS)’s growth trajectory. The company made substantial loan principal payments and entered a $250 million accounts receivable securitization facility in order to reduce its net debt. It targets achieving a leverage ratio of between 1.5 – 2.5 times and is confident in achieving the goal.
For the full year, Vestis Corporation (NYSE:VSTS) is expecting a positive pricing impact of between 1% – 2%. Moving forward, it will focus on customer experience and leveraging national account wins to fuel volume and operating leverage. Vestis Corporation (NYSE:VSTS) has been implementing initiatives in a bid to enhance customer service quality, which includes addressing shortages and ensuring on-time delivery.
Overall, Vestis Corporation (NYSE:VSTS)’s efforts to win large national accounts and optimize operations, like logistics and merchandise management, should help fuel future success. The company expects fiscal 2024 Adjusted EBITDA margin to be towards the higher end of the range of 12.0% – 12.4%, inclusive of ~$18 million in incremental public company costs. Its strategic imperatives consist of disciplined capital allocation with deleveraging as a priority.
In Q3 2024, Vestis Corporation (NYSE:VSTS) saw FCF of $125 million in fiscal year-to-date, reflecting a rise of 22.6% YoY. Wall Street believes that the company has maintained its emphasis on leveraging its strong cash flows and effectively managing the balance sheet.
As of Q2 2024, 34 hedge funds reported owning stakes in Vestis Corporation (NYSE:VSTS).
1) PHINIA Inc. (NYSE:PHIN)
Market Cap as of 9 October: $1.96 billion
Number of Hedge Fund Holders: 35
PHINIA Inc. (NYSE:PHIN) is engaged in the development, design, and manufacture of integrated components and systems optimizing performance, increasing efficiency, and reducing emissions in combustion and hybrid propulsion for commercial and light vehicles, and industrial applications.
With expectations for battery electric vehicles (BEVs) undergoing recalibration, the company’s focus on ICE efficiency improvements places it well in the market. PHINIA Inc. (NYSE:PHIN)’s strategy goes beyond its current stronghold in the light vehicle (LV) market. The company focuses on diversifying its revenue streams by increasing its exposure to commercial vehicles (CV) and aftermarket (AM) segments.
PHINIA Inc. (NYSE:PHIN) aims to achieve a mix in which LV makes up ~30% of revenue by 2030. Wall Street believes that this diversification strategy should drive long-term growth as CV and AM segments typically provide increased margins and offer significant resilience in the challenging environment. Expected drivers for PHINIA Inc. (NYSE:PHIN)’s stock consist of potential original equipment manufacturer (OEM) announcements, together with additional cash return announcements.
Despite challenging commercial and light vehicle markets, the company’s aftermarket business and new product pipeline, consisting of alternative fuel products, should enable strong growth. PHINIA Inc. (NYSE:PHIN) expects to leverage its brand, capabilities, and scale in a bid to navigate through market softness and deliver strong shareholder value.
Analysts at UBS Group initiated coverage on the shares of PHINIA Inc. (NYSE:PHIN) on 4th September. They gave a “Buy” rating and a $55.00 price target. Ariel Investments, an investment management company, released its first-quarter 2024 investor letter. Here is what the fund said:
“Manufacturer of premium fuel and electrical systems, Phinia Inc. (PHIN) also traded up in the period on solid earnings results and a positive full year 2024 outlook. Healthy consumer pricing, new business wins across all end markets, ongoing weakness in electric vehicles, growth in light vehicle original equipment and strong cost controls, more than offset disappointing commercial vehicle sales in China. Meanwhile, management continues to prioritize capital returns to shareholders via buybacks and dividends. Looking ahead, we expect PHIN to deliver sustainable, profitable growth and significant cash generation as it captures operational efficiencies, exits agreements with its former parent company BorgWarner Inc. and also expands its industrial and aftermarket customer base.”
While we acknowledge the potential of PHIN as an investment, our conviction lies in the belief that some deeply undervalued AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for a deeply undervalued AI stock that is more promising than PHIN but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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