Market Strategists Say the Best Investment Opportunities Now Are in Small-Cap Stocks. 5 Stocks to Buy if They’re Right. | The Motley Fool

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These small companies have viable paths to creating long-term shareholder value and are timely opportunities today.

If you’ve been investing for less than 20 years, then you’ve never experienced the stock market opportunity that exists right now. And if you have been investing that long, you know the present opportunity is rare.

The S&P 500 is an index (collection of stocks) that holds about 500 of the biggest, most profitable U.S.-based public companies. By contrast, the Russell 2000 holds 2,000 of the smallest stocks. And over the past year, these two indexes have gone in completely opposite directions.

According to people who track this kind of thing, the disparity between large-cap stocks and small-cap stocks is the greatest it’s been in over 20 years. And some market strategists say this is where opportunity lies.

For example, Shadman Riaz — a fund manager at investment company Fidelity — recently said that small-cap stocks are, “Under-followed and under-loved, which has created a good setup for them.”

I agree that there are great long-term buying opportunities in the small-cap stock space. And it’s why I want to bring five stocks to you today: Tripadvisor (TRIP -1.44%), Xometry (XMTR 3.96%), PubMatic (PUBM -0.50%), Lovesac (LOVE -2.45%), and Kura Sushi (KRUS 0.86%). Here’s why they could be great buys.

In late 2011, travel company Expedia spun off Tripadvisor into its own publicly traded company. The day of the spinoff, Tripadvisor stock was trading at around $29 per share. Today, it trades at closer to $17 per share, meaning it’s lost money for shareholders over the last 12 years.

Don’t be fooled by its terrible performance to date. The company has a surprising ace up its sleeve.

Tripadvisor owns a booking platform in the experiences category called Viator. And Viator is quickly stealing the show. Through the first three quarters of 2023, Viator accounted for 41% of Tripadvisor’s total revenue. Moreover, Viator’s revenue is up a stellar 57% from the comparable period of 2022.

Tripadvisor stock trades at a paltry 1.4 times trailing sales, reflecting dismal expectations from the market. However, Viator gives the company options. It can hold it and ride its growth higher as it makes up a bigger percentage of the overall business. Or it can take a play from Expedia’s book and spin Viator out into its own company, unlocking value for Tripadvisor’s shareholders.

Either way, Viator puts Tripadvisor stock in a good position to reverse its long-term losing streak.

Xometry is a digital marketplace for online manufacturing. The company competes largely with independent machine shops, which often don’t have the technological prowess to replicate what it’s building — great for Xometry’s competitive positioning. Moreover, the opportunity is enormous considering the manufacturing market is valued at over $2 trillion.

When someone needs something built, they navigate to Xometry’s platform and its artificial intelligence (AI) delivers an instant quote for the job. Big businesses appreciate this speed and are increasing their adoption. The company has over 1,000 customers spending $50,000 or more annually as of the third quarter of 2023, up from 389 two years ago.

Moreover, new buyers on Xometry in 2022 spent nearly three times more on average than new buyers in 2019. This metric has been increasing annually without fail.

Once Xometry gives buyers a quote, it outsources the jobs to independent third parties. The difference between what the company quotes for the job and what it pays to have it done is its gross profit. Therefore, its gross profit depends on its AI pricing jobs appropriately.

Xometry has more work to do. But the chart below shows meaningful outperformance for its gross profit relative to revenue growth, which indicates things are trending in the right direction for long-term investors.

Before I highlight advertising-technology (adtech) company PubMatic, I want to quickly talk about a widespread investing risk. Small-cap stocks are cheap, yes. But according to analysis from Bank of America, it might be because small-cap stocks have more debt maturing over the next few years compared to large-cap stocks. This debt will need to be repaid or refinanced at higher rates, which makes small-cap stocks more risky today, generally speaking.

This could reasonably explain why small-cap stocks are down. However, if you’re worried about this, these next three small-cap companies are completely debt-free and consequently sidestep this possible risk entirely.

PubMatic partners with publishers to sell their digital ad space. The company owns its infrastructure and is delivering greater efficiency with scale. In the third quarter of 2023, ad impressions — the amount of times ads were shown — were up 33% year over year. But the cost of impressions was down 9%, helping this small outfit remain profitable.

Right now, spending on digital ads is down due to macroeconomic conditions. PubMatic’s ad rates and revenue are, therefore, down as well. However, with impressions up, the company is in a great position to benefit whenever ad spending picks back up. And it may be picking back up already considering PubMatic is guiding for fourth-quarter revenue of $76 million to $80 million, which would be a quarterly record.

The Lovesac Company is a furniture company specializing in oversized beanbags and sectional couches. This is a premium brand with premium pricing, so sales could struggle in a slowing economy. Accordingly, in the company’s fiscal second quarter of 2024 (which ended on July 30), net sales were only up 4%.

However, thinking more long term, Lovesac’s sectional couches — called Sactionals — may benefit from consumer loyalty more than any other furniture brand. The company has customizable features, including different colored replaceable covers as well as surround sound and charging options. Moreover, customers can add sections to their Sactionals over time and everything Lovesac makes is backwards-compatible.

Therefore, whereas most furniture companies only get repeat customers infrequently, Lovesac has many ways to generate revenue from its customer base.

Even in this slower fiscal 2024, Lovesac still expects to grow net sales. And the company expects a full-year net profit of $20 million to $29 million. In short, I believe this is a low-risk stock in the current market, thanks to its profitability and debt-free balance sheet. And it will be aptly positioned for market-beating gains when sales growth picks back up.

Finally, Kura Sushi might be the most obscure and volatile stock on this list. But this small restaurant chain of only 54 locations might also be the most fun idea on this list.

When visiting one of its restaurants, you use the Kura Sushi app to get a table, grab a plate as it goes by on a conveyer belt or order from the on-table tablet, and when you’re done eating just put your plates on the conveyer belt to be counted for billing and robotic dishwashing. And after 15 plates, diners get a free toy — I told you this was a fun idea.

Perhaps because it’s a fun idea, Kura Sushi is able to attract tons of diners. The company was able to generate about $4.3 million in average annual sales per location in its fiscal 2023 (ended in August), which is really high. And with high sales per location, it had a restaurant-level operating profit margin of 21.9%.

Kura Sushi’s restaurant-level profitability is approaching the 26.3% margin of highly successful restaurant chain Chipotle Mexican Grill.

Restaurant-level profitability excludes corporate-level expenses and pre-opening costs for new restaurants, which can be substantial for a small company like Kura Sushi. But with discipline, this company can get more profitable with growth, as these substantial expenses get to be a smaller percentage of revenue.

Growth is indeed on the menu for Kura Sushi. The company hopes to have more than 290 U.S. locations long term compared with just 54 today. It’s already a profitable business but it could become far more profitable as it more than quintuples its footprint. Therefore, I believe Kura Sushi stock has a good chance at market-beating upside from here.

With Kura Sushi and the other four, I’m not suggesting that these stocks are set up for a short-term bounce-back after recent struggles — these stocks are all down 25% or more from their 52-week highs. I’m suggesting that each of these companies can beat the market over the long term if things go well. And I believe each is undervalued today, providing good opportunities for investors.

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