We recently compiled a list of the Top Investors’ Stock Portfolio: 7 Small-Cap Stocks to Invest In. In this article, we are going to take a look at where Vestis Corporation (NYSE:VSTS) stands against the other small-cap stocks.

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 16^th 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).

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).

Overall VSTS ranks 2nd on our list of the small-cap stocks to invest in. While we acknowledge the potential of VSTS 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 VSTS 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.