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Small-cap stocks are generally companies with a market cap above $250 million, but below the $2 billion threshold. They usually consist of up-and-coming companies with rapid growth potential, which offer higher returns - but also carry greater risks than their larger, more established competitors.
Recently, investors have been rotating out of the Big Tech market leaders, while small-cap stocks have benefited from a wave of buying interest as Fed rate-cut expectations rise. The sudden shift has propelled the underperforming Russell 2000 Index (RUT), a benchmark of small-cap stocks, sharply higher over the past week.
After spending most of 2024 flat to slightly lower, the iShares Russell 2000 ETF (IWM) is now more than 9% higher on a YTD basis, quickly closing the performance gap with the Nasdaq-100 Index ($IUXX)-tracking Invesco QQQ ETF (QQQ).
Tom Lee’s Bull Case for Small-Cap Stocks
The bullish sentiment on small-caps was underlined by Tom Lee, head of research at Fundstrat, to start the week. He believes that small-cap stocks make the “most compelling near-term investment case,” and predicts this move higher could last 10 weeks, with an eventual magnitude of up to 40%.
Lee provided five main reasons that are fueling his optimism about the small-caps. First and foremost is the probability of a September rate cut, as the odds have now risen to 99% for an easing move. Since smaller companies are more sensitive to these changes, the analyst expects any rate cut would be particularly beneficial to small-caps.
Second, Lee pointed out IWM’s surge in the fourth quarter of 2023 as traders priced in rate-cut hopes, and thinks that an actual rate cut could trigger a “larger and longer rally” this year. Third, he argued that sentiments towards regional banks are improving, and they represent a significant part of IWM’s financial services sector. Fourth, Lee believes that investor’s inflation expectations are too high at the moment, and when lowered, will provide “fuel for small-caps.”
Finally, the analyst said that the risk premium to hold small-cap debt over large-cap debt is narrowing, and a decrease in this “quality spread” is typically an indicator of rising investor confidence in small-caps - which is often tied to their outperformance.
Blue Bird Stock Outperforms the Market
One small-cap stock that's been outperforming the market for a while now is Blue Bird Corp. (BLBD), an American bus manufacturing company out of Fort Valley, Georgia. The company operates in two segments: the bus segment oversees the designing, engineering, manufacturing, and marketing of school buses, while its parts segment oversees the sales of replacement parts.
Valued at $1.68 billion by market cap, BLBD is a component of the Russell 2000 Index. Blue Bird serves more than 60 countries globally across Africa, Asia, Latin America, Europe, and the Middle East, but like most small-cap companies, the majority of its revenue is still derived from the U.S.
Blue Bird stock has surged 115.9% over the past 52 weeks, and the stock is up 88.8% YTD - outperforming not only its parent RUT index, but also the large-cap S&P 500 Index ($SPX).
Blue Bird Reports Excellent Q2 Results
Blue Bird reported its fiscal Q2 earnings on May 8, with revenue of $346 million increasing 15.4% YoY, and also surpassing analysts' estimates of $298.41 million. Bus sales were up $44.5 million, led by an 18.8% increase in average sales price per unit, even as units booked dipped by 2.2%.
The school bus company also reported adjusted EPS of $0.89 per share, which beat the consensus forecast by a wide margin. Adjusted EBITDA reached $46 million, marking a new Q2 record and reflecting a 13% margin.
Management also raised its full-year guidance for FY24, with net revenue now expected between $1.275-$1.325 billion, adjusted EBITDA in the range of $145-$165 million on 11.5%-12.5% margin, and adjusted free cash flow of $70-$80 million. At the midpoint of that forecast, adjusted EBITDA of $155 million with 12% margin would be a new full-year record for Blue Bird.
Further, management is raising its long-term profit outlook toward an adjusted EBITDA margin of 14%+ on revenue of roughly $2 billion.
Blue Bird Wins DOE Grant
The school bus company recently announced that it has won an $80 million grant from the Department of Energy, which allows the company to expand its electric vehicle (EV) production capabilities. The move comes as part of the previously announced federal investment in EV infrastructure.
Blue Bird plans to transform its diesel-powered motorhome manufacturing site located in Fort Valley, Georgia, into a state-of-the-art electric vehicle production facility. This will assist them in meeting the rising demand for its type-D electric school buses. The company noted that the DoE award is subject to final contract and negotiations, which could take up to 120 days.
What Do Analysts Think of BLBD?
BLBD is well-loved by analysts, who have a consensus “Strong Buy” rating. Out of 7 analysts in coverage, 6 say it's a “Strong Buy,” while 1 says it's a “Moderate Buy.”
BLBD trades nearly flat with its mean price target of $51.86, but the Street-high target of $66 suggests upside potential of nearly 30% from here. Priced at 19.3x forward adjusted EPS and 1.28x sales, this breakout small-cap stock still looks like a reasonable buy.
On the date of publication, Ruchi Gupta did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
