Stanley Druckenmiller is one of the richest people in the world, with a net worth of $6.2 billion as of this writing, according to the "Real-Time Billionaires List" from Forbes. And he was able to pad his numbers with an extremely timely investment in Nvidia (NVDA -2.09%).
In the fourth quarter of 2022, Druckenmiller bought over 580,000 shares of Nvidia for his investment firm Duquesne Family Office. As of the first quarter of 2024, he's reduced his stake in Nvidia down to about 176,000 shares. But that's after riding his position to enormous gains.
Druckenmiller swapped out shares of one of the most valuable companies on earth -- Nvidia -- with shares in something that's on the other end of the spectrum entirely. A May filing revealed that Duquesne Family Office had purchased a position in the iShares Russell 2000 ETF (IWM -1.46%), roughly valued at $700 million right now.
Most investors are aware of the S&P 500 -- an index of 500 of some of the largest companies on the stock market. But fewer are aware of the Russell 2000 index, which is for small-cap stocks. In short, Druckenmiller expects shares of smaller companies to generally perform well from here.
There's good reason to believe this. According to Yardeni Research, valuations for large-cap stocks and small-cap stocks were comparable before the pandemic. But right now, the average forward price-to-earnings (P/E) ratio for the S&P 500 is about 22, whereas the forward P/E for the S&P SmallCap 600 is about 15 -- more than 30% cheaper.
Smart investors see this valuation gap between the big companies and the small ones. The small ones are being overlooked and are consequently cheap, which creates an opportunity that Druckenmiller apparently wants to exploit.
It may have been a timely bet. As the chart shows, performance for the Russell 2000 is quickly perking up, with the corresponding exchange-traded fund (ETF) jumping 13% in just the past month.
For investors looking to follow Druckenmiller's moves, they could buy shares of the iShares Russell 2000 ETF like he did. But remember that this is a bet on small-cap stocks in general. He likely made a generalized bet because he has too much money to invest. He can't pick individual small-cap stocks because he would acquire too big of a stake, running into regulatory issues and potentially moving the market.
By contrast, most regular investors can buy top small-cap stocks without worrying about controlling too much of the company. Identifying the best ideas in the small-cap space might be a better way to imitate Druckenmiller in this case. And I have three ideas for investors to consider: Xometry (XMTR -1.07%), Driven Brands (DRVN -0.98%), and PubMatic (PUBM -2.14%).
1. Xometry
Xometry operates an online marketplace for the manufacturing industry and powers it with its artificial intelligence (AI) software. Without getting into the weeds, I believe that the numbers suggest that its AI-powered platform offers players in this space something special.
At the end of 2019, Xometry only had 11,500 active buyers total, and less than 300 of these spent more than $50,000 annually. But as of the first quarter of 2024, the company had 58,500 active buyers, with nearly 1,400 spending more than $50,000 annually. That's a lot of traction in a short time for a small platform. And it suggests that the platform is good enough to attract users.
Xometry has less than $500 million in annual revenue in a space valued in the hundreds of billions of dollars -- upside potential is likely if it's true that its platform offers users something better than what they're used to.
The company isn't profitable yet. But it's getting closer to positive cash flow with scale, which is why this is an interesting idea now. Once it's profitable, more investors will likely take notice, giving an advantage to investors today who noticed the improvement beforehand.
XMTR Revenue (TTM) data by YCharts
2. Driven Brands
Driven Brands is a company that uses a roll-up strategy in the automotive space. It operates several different chains, including car washes, mechanic shops, and windshield repair. The idea is that by rolling up a bunch of companies under one parent company, it can benefit from brand recognition and economies of scale.
There are admittedly headwinds for Driven Brands right now. For example, in the first quarter of 2024, its car wash division accounted for 25% of revenue, but revenue in this segment was down about 8% year over year. And management only expects about 4% top-line growth for its business as a whole this year, which isn't very exciting.
Driven Brands has an enterprise value of $5 billion (for the record, this is technically a mid-cap stock, not a small-cap stock). And in 2024, management expects adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of at least $535 million. That means the company is valued at just 9 times its profits.
I mentioned enterprise value and EBITDA because these are metrics commonly used for companies with high levels of debt. Driven Brands has $2.9 billion in long-term debt, mostly because of its roll-up strategy. That's a heavy load, but it explains why it's cheap right now: Interest rates are up, lowering investor appetite for companies with debt.
I like Driven Brands because it operates boring businesses that are always in demand. And its strong adjusted profits make me comfortable with its debt. But if interest rates drop, I believe the market will give it more credit than it's giving it now. Economists believe it's increasingly likely that interest rates will drop before the end of 2024, which is why this is an idea to consider right now.
3. PubMatic
Finally, PubMatic is a programmatic advertising-technology (adtech) company that's as financially secure as any small-cap stock around. For investors worried about the economy, this is a small player that can press on through hard times.
Regarding its financial fortitude, PubMatic has $174 million in cash, equivalents, and short-term investments. The company doesn't have long-term debt and doesn't plan to. Moreover, it generates positive cash flow.
PubMatic is in a good place competitively as well. The company partners with publishers to get ad space sold. There are a lot of small players here. But with PubMatic's supply optimization product, it helps its customers go from many software providers to just two or three, leaving itself in the mix, of course.
Digital advertising is facing a slowdown as consumer spending cools. But this is routine from a macroeconomic perspective. Whether it's next week or next year, spending will rebound, and digital advertising will perk up, to PubMatic's benefit. And thanks to its financial fortitude, it can afford to calmly wait things out until then.
PubMatic's growth rate has accelerated recently, so I think this business will bounce back sooner rather than later. And that's why PubMatic joins Xometry and Driven Brands as smaller, undervalued companies I believe investors should consider buying now, following Druckenmiller's current conviction for small-cap stocks.
