It is Expected That Small Caps Will Outperform in 2024. Five Stocks Are Recommended by a Value Investor

As 2023 draws to a close, Royce Investment Partners portfolio manager Miles Lewis sees potential for a breakout in small-cap stocks heading into 2024, even in the face of a potential economic downturn. Lewis believes that the concerns surrounding a recession or economic slowdown, often cited as a risk factor, are already priced into small caps.

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The broader market has experienced upward momentum, with traders anticipating lower interest rates in 2024. The Federal Reserve's decision to keep benchmark interest rates unchanged in December and its projection of three rate cuts in the coming year fueled optimism, leading to 52-week highs for all three major indexes.

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Lewis is optimistic about the prospects for small caps in the upcoming year. The Russell 2000 index, considered a gauge of the economy's true health, has gained approximately 13% in 2023, while the S&P 500 has seen a nearly 25% climb.

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He attributes his positive outlook to factors such as an overconcentration in the "Magnificent Seven" stocks, attractive valuations for small caps, and the current period of low returns, which may pave the way for a more favorable environment for small caps.

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Lewis identifies his top five stocks for 2024:

1. Home BancShares (HOMB): A regional bank based in Arkansas, Lewis sees potential for margin expansion and long-term growth trends as interest rates fall. The bank's expansion in Texas and Florida is viewed as advantageous, and Lewis emphasizes its robust balance sheet.
2. Advance Auto Parts (AAP): Lewis views this distressed automotive parts company as a "recession-resistant business" that can thrive in a weaker macroeconomic environment. Despite recent challenges, he expects the company's shares to rise as margins improve and the core business remains strong.
3. Repay Holdings (RPAY): A payment processing company that Lewis sees as strong despite the waning sentiment for fintech stocks. Lewis highlights its attractive valuation and structural tailwinds, expecting the company to grow nicely at a reasonable valuation.
4. Air Lease (AL): An aircraft lessor that Lewis believes is well positioned, especially with a fleet of narrow-body planes experiencing increased demand. He anticipates a reversal in the share price lag due to a rapid increase in interest rates in 2023.
5. Ziff Davis: A digital media company benefiting from repeat customers and growing ad revenue. Lewis sees Ziff Davis as well positioned for growth through mergers and acquisitions in 2024, leveraging its substantial cash pile.

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While acknowledging challenges and setbacks in some of these stocks, Lewis remains optimistic about their potential for growth in the coming year. As the market dynamics evolve, the performance of small-cap stocks will be closely watched, and Lewis believes the pieces are in place for a significant rally in this asset class.