'Incredibly compelling': The pros love small-cap stocks right now. Here are their top picks

Published Wed, Sep 20 20238:43 PM EDT

The conditions are right for buying small-cap names, according to many analysts and investors. Matt Orton, chief market strategist at Raymond James Investment Management, was the latest to urge investors to "strategically add" to small-cap stocks right now. He said he has liked the small-cap sector for a few months now, and the backdrop has improved with the Russell 2000 — a small-cap U.S. index — "bouncing off key support" and beating the S & P 500 again. "Valuations remain incredibly compelling, earnings are bottoming and re-accelerating into FY24, and the trend of reshoring and continued capex all provide tailwinds," he told CNBC's " Street Signs Asia " on Monday. He said small-caps can continue to outperform if interest rates remain volatile and "don't break out to the upside." Orton said if the Russell 2000 stays at the 1,900 level, he would call for a long position as the chances of a "long-term breakout" increases, especially if it crosses 2,000. He likes the industrials and IT areas, calling them "higher conviction." Tom Ognar, senior portfolio manager at Allspring Global Investments, said small- and mid-cap stocks look the "most incrementally interesting" among growth stocks. "We're very attuned to the valuation discounts currently being afforded to small- and mid-cap stocks after protracted periods of underperformance relative to large-cap stocks," he said. This year has been a lot better than the last for investors focused on growth stocks, and Ognar said the rally could extend to the broader market. "What I think happens is we start to broaden out, I think you'll start to see more participation with small- and mid-cap stocks," he told CNBC'S " Squawk Box Asia " on Thursday. Bank of America also said late last month that it's becoming more optimistic about the chances of an economic recovery — and it believes the biggest winners in the inflection period could be small-cap stocks. It screened for the best small-cap stocks to play an economic recovery. Stock picks These are the small- and mid-cap stocks Ognar likes at the moment: Allegro Microsystems : He called it an "innovator designer" of sensor and power integrated circuits for the auto and industrial markets, with electrification and the autonomous trend being "two powerful growth drivers." Shoals Technologies Group : Ognar flagged its low-cost services for utility scale solar energy projects, with new growth areas in solar storage and automotive electric vehicle charging. RBC Capital Markets also released, in a September note, an updated list of what it called "high conviction" U.S. small-cap growth recommendations. These are companies it says have an "attractive normalized growth story or strong durable growth characteristics." Automotive services company Valvoline is one of the additions. RBC said it's one of the few names in the broadline category — retailers dealing in high volumes at the cheaper end of a product line — that "can work regardless of how the macro progresses." RBC said Valvoline is largely still under investors' radar and has a "compelling valuation" — at a 12.5x enterprise value to earnings before interest, taxes, depreciation, and amortization ratio (EV/EBITDA). RBC gave the stock a price target of $43 — or potential 32% upside. It also added fintech company Clearwater Analytics , which it said has "margin expansion potential, and an underappreciated ability to sustain 20%+ growth for the next several years." It gave Clearwater a price target of $22, or potential 13% upside. Finally, RBC added Xenon Pharmaceuticals , which it called a "high conviction play on the treatment of epilepsy and depression." RBC said its late-stage epilepsy trials have a high probable success rate, and believes it's set to generate "near-blockbuster revenue and set a solid valuation floor." "Additionally, we believe investors are underappreciating the near-term upside opportunity in another indication, depression, given signals of promise from a predecessor drug," RBC said. It gave Xenon a price target of $51, or potential 38% upside. — CNBC's Michael Bloom contributed to this report.