Suzanne Franks, a seasoned money manager at First Eagle Investments, has dedicated her career to studying and investing in small-cap stocks, despite the fact that cab drivers aren’t yet discussing them. However, there’s been growing chatter on Wall Street about these smaller companies, catching the attention of investors like Franks.
David Lefkowitz, head of U.S. equities America for UBS Wealth Management, recently outlined several catalysts for potential small-cap outperformance in a client note. These catalysts include increased access to capital, a favorable environment for merger-and-acquisition activity, improved business sentiment, and the prospect of interest-rate cuts. While the anticipated inflection point hasn’t yet arrived, Franks and her team seized the opportunity presented by market volatility to scoop up bargains.
Franks, an alumna of the University of Chicago Booth School of Business, boasts an impressive background in small-cap investing. She founded an independent research firm focused on event-driven investment opportunities before spending a decade as part of a small-cap team at Royce Investment Partners. In 2021, she joined First Eagle, where she currently serves as an associate portfolio manager on the $1.8 billion First Eagle Small Cap Opportunity fund, which has delivered a solid 15% return over the past year.
In an interview with Barron’s, Franks shared her bullish outlook on small-cap stocks. Despite a challenging decade for these companies, with the Russell 2000 index returning just half the average annual return of the S&P 500, Franks sees a pivotal moment ahead. She notes that small-cap valuations are historically low, with the Russell 2000 Value index trading at just 13 times estimated 2024 earnings, near financial-crisis levels. Franks believes this low valuation reflects significant uncertainty and bad news, presenting an opportunity for investors.
Franks identifies potential catalysts for a turnaround in small-cap stocks, including the Federal Reserve’s decision to maintain higher interest rates for longer periods, which has raised concerns about financing for small companies. However, she remains optimistic, anticipating a potential inflection point in sentiment. Despite broader economic concerns, Franks has observed positive sentiment among many smaller companies, particularly in terms of revenue generation and cautious optimism regarding future prospects.
In summary, Franks’ bullish stance on small-cap stocks stems from her belief in their undervaluation and the potential for a sentiment shift. While challenges persist, she remains optimistic about the resilience and potential of smaller companies, emphasizing the importance of company-level execution in driving future valuation growth.
Franks’ optimism regarding small-cap stocks is further fueled by several factors beyond their undervaluation. One significant indicator is the robust merger-and-acquisition (M&A) activity within the companies in which her team has invested. Already this year, seven companies have been acquired, compared to 14 in the previous year. Franks sees this uptick in M&A as a testament to the attractiveness of small-cap companies at their current valuations. Additionally, the stabilization of interest rates and a more moderate pace of economic growth are creating a favorable environment for further M&A activity.
When it comes to the types of companies that pique her interest, Franks emphasizes the importance of strong business leadership and financial resources, coupled with clear catalysts for change. She looks for companies that are actively addressing the underlying issues affecting their valuation and profitability. These catalysts may include strategic initiatives to improve operations, increase efficiency, or capitalize on emerging market opportunities.
One such company that fits this description is Kaiser Aluminum, a manufacturer of flat-rolled plate and sheet used in aerospace and beverage can production. Despite trading at a historically low valuation, Kaiser Aluminum is strategically positioned to benefit from improving market conditions. The company is expanding its manufacturing capacity to meet growing demand from aerospace customers, while also capitalizing on environmental trends favoring aluminum over plastic in packaging.
Franks has also been adding consumer discretionary stocks to her portfolio, including companies like Cheesecake Factory. Despite challenges in the restaurant industry, Cheesecake Factory presents an opportunity for growth due to its accelerating expansion plans and efforts to improve operational efficiency. Similarly, H&E Equipment Services, a provider of construction equipment, stands to benefit from strong demand in nonresidential construction and infrastructure projects.
Another stock on Franks’ radar is Matador Resources, an exploration-and-production company focused on oil-rich energy plays. Franks sees potential in Matador’s undervalued assets and ongoing efforts to optimize production and increase efficiency. Additionally, recent management changes at companies like Stericycle are seen as positive catalysts for improving operational performance and ultimately driving margin expansion.