3 Small-Cap Stocks in the Russell 2000 Set to Rally

Key Points

• As a Wall Street legend sells out of NVIDIA and backs up small capitalization stocks, investors now have an opportunity to build their own views.
• Three stocks stand out in both a technical and a fundamental way, causing Wall Street to become bullish.
• A double-digit upside lies ahead for the small caps, but the potential bull run is solid in these names.

There has to be a reason why Stanley Druckenmiller—the guy who traded shoulder-to-shoulder with George Soros—decided to make a radical move in the past couple of weeks. The legendary investor saw it fit to sell out of his previous NVIDIA Co. NASDAQ: NVDA holdings and instead look to buy exposure in small-cap stocks through the iShares Russell 2000 ETF NYSEARCA: IWM.

Today, the Russell 2000 ETF is highly correlated to the iShares 20+ Year Treasury Bond ETF NASDAQ: TLT, which hasn’t happened since the last business cycle. This means that if the Federal Reserve cuts rates by September 2024, both bonds and small caps could rally.

The problem for retail investors is that they don’t have billions like Druckenmiller, so they must take this strategy further. How? Well, instead of buying into the overall ETF, they attempt to pick out the best deals inside of the ETF. These deals include Sprouts Farmers Market Inc. NASDAQ: SFM, Murphy Oil Co. NYSE: MUR, and even Duolingo Inc. NASDAQ: DUOL.

Sprouts Farmers Market Stock Attracts Higher Investor Valuation

Sprouts Farmers Market stock shares are now trading at a new all-time high, and there’s a good reason for that. Before discussing the reasons behind the stock's rise, investors should understand the challenges Sprouts faces.

Compared to other great companies in the retail space, such as Target Co. NYSE: TGT and Kroger NYSE: KR, investors can’t help but notice that Sprouts Farmers Market stock stands out in a few valuation metrics.

On a forward P/E basis, Sprouts trades at a 23.5x multiple today, which compares to Target stock’s 14.2x to command a premium of over 65.4%. Pegged against Kroger stock, Sprouts also calls for a premium of 118% as Kroger only trades at a forward P/E ratio of 10.8x today.

Stocks trade near their highs and at premium multiples for a reason, and for Sprouts, the answer can be found in the company’s financials. Over the first quarter of 2024 earnings results, management posts net revenue growth of 9% over the year, which stands above the industry’s average.

More importantly for investors, the company generated $219.7 million in operating cash flows (a 22.1% jump over the year), and with only $51.2 million in capital expenditures, the company walked out with $168.5 million in free cash flow.

This enabled management to repurchase up to 2 million shares over the quarter, further boosting the stock’s path. Sprouts Farmers Market stock’s short interest declined by 11.3% in the past month, further boosting this momentum.

Buffett's Influence: Why Murphy Oil Stock Is a Smart Bet

There are other reasons to look into Murphy Oil stock beyond its inclusion in the Russell 2000 ETF. Recently, Buffett went on a nine-day buying streak in shares of Occidental Petroleum Co. NYSE: OXY to show his interest in the energy sector.

Because of Buffett’s presence in the space, other stocks may interest investors looking to ride in his coattail, but here’s why Murphy Oil stock is the smart bet. To put it bluntly, it is a growth machine. Wall Street analysts expect up to 46% growth in earnings per share (EPS) for the next 12 months.

This growth rate is above Buffett’s Occidental stock pick, as analysts only forecast 29.2% for that stock. Riding on these tailwinds, analysts at Mizuho Financial felt comfortable enough to boost Murphy Oil stock’s price target up to $59 a share, daring it to rally by as much as 45.6% from where it sits today.

Duolingo: The Unmissable Tech Stock in Today's Market

As the technology sector gains the market’s attention, stocks like NVIDIA take the helm, driving the market indexes higher. However, NVIDIA stock has lost up to 10% in value over the past trading week.

Lucky for small-cap investors, not all technology stocks are made equal, which is where Duolingo’s growth comes into play. After trading down to 82% of their 52-week highs, shares of Duolingo stock have a lot of ground to cover if they want to catch up to the rest of tech. Here’s how that catch-up may be realized in the coming quarters.

Wall Street analysts now forecast up to 51.7% EPS growth for Duolingo stock this year, above and beyond NVIDIA’s projections for only 23%. Despite being in entirely different industries, these two divergences should be enough to get the market’s attention.

Duolingo stock is good enough for analysts at Piper Sandler to boost their valuations to $265 a share, directly calling for the stock to rally by 28% from where it trades today.

More than that, the Vanguard Group boosted its stake in Duolingo stock in the first quarter of 2024 by a rate of 4.1%. Today, the asset manager’s net position in Duolingo stock is $753.2 million, part of the nearly $1 billion in institutional inflow over the past 12 months.