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.
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).
A homebuyer signing a stack of paperwork with a title insurance representative.
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.
Overall STC ranks 7th on our list of the small-cap stocks to invest in. While we acknowledge the potential of STC 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 STC but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
