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).
Interior of a large office building - reflecting the company's various commercial properties.
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.
Overall GNL ranks 6th on our list of the small-cap stocks to invest in. While we acknowledge the potential of GNL 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 GNL but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
