By Philip van Doorn
The company went public in December 2020. This is an early-stage play, with small-cap-like characteristics, including that very high forward P/E. But the high P/E isn’t meaningful at such an early stage, when a rapidly growing company focuses on growth in lieu of showing a profit.
Wall Street analysts expect the company’s rapid growth to continue, as you can see on the table, above, and Zhang expects profit margins to improve “as they scale.”
Signature Bank /zigman2/quotes/204403715/composite SBNY -0.37% of New York is a rapidly growing regional player in an industry that most investors don’t associate with growth. That expected 19.3% revenue CAGR from 2021 through 2023 is the highest among the 24 banks in the KBW Bank Index /zigman2/quotes/210598427/realtime BKX -2.38% . (The index includes the largest U.S. banks, except for investment banks.)
Zhang believes “there is room for multiple expansion,” because the stock’s forward P/E ratio is in line with slow-growing midcap banks.
She is especially impressed with Signature Bank’s Signet digital-payments platform, which allows real-time payments between commercial customers at all times. Signet makes use of blockchain technology. The real-time aspect of the service is more significant than you might think — bank transaction processing has traditionally been an overnight business, as mainframe computers process billions of transactions in batches outside business hours.
Zhang said Signet illustrates the bank’s “optionality in crypto” as bitcoin and other digital currencies are more widely adopted.
Herc Holdings Inc. /zigman2/quotes/209084505/composite HRI +0.26% leases heavy equipment through subsidiaries, including Herc Rentals. It operates through more than 270 locations in North America. The company was spun off by the old Hertz Holdings (now known as Hertz Global Holdings Inc. ) in June 2016.
Herc has two larger U.S. competitors: United Rentals Inc /zigman2/quotes/204230955/composite URI -1.39% and Sunbelt Rentals, a unit of Ashtead Group PLC /zigman2/quotes/200232063/delayed UK:AHT -4.36% /zigman2/quotes/205937616/composite ASHTY -3.34% . Zhang called Herc “a catch-up play” that is well-positioned to take market share because its management team had right-sized costs and replaced its aging rental fleet.
She expects Herc’s margins to improve and cause a “re-rating” of the company by investors, which mean an expansion of the P/E multiple.
The prospects of an infrastructure bill passed by Congress and signed by President Biden would provide a tailwind to the company, Zhang said. Aside from the political developments, “we all know the supply-chain issue that has held up projections this year. Herc is a solution for that,” she added.
A discounted group of stocks
Large-cap stocks get most of the coverage in the financial media — rightly so, considering how rapidly and consistently the leaders of the technology world have grown. Broad index funds are excellent low-cost investments, but if you are in one, it might surprise you how much of your money is concentrated in a small number of stocks.
For the best example, the SPDR S&P 500 ETF Trust /zigman2/quotes/209901640/composite SPY -0.24% is 22% concentrated in only five companies: Microsoft Corp. /zigman2/quotes/207732364/composite MSFT +1.77% , Apple Inc. /zigman2/quotes/202934861/composite AAPL -1.16% , Amazon.com Inc. /zigman2/quotes/210331248/composite AMZN -1.02% , two common-share classes of Google holding company Alphabet Inc. /zigman2/quotes/205453964/composite GOOG +0.66% /zigman2/quotes/202490156/composite GOOGL +0.52% and Facebook Inc. /zigman2/quotes/205064656/composite FB +1.48% .
The S&P 500 Index /zigman2/quotes/210599714/realtime SPX -0.17% is considered the U.S. benchmark, and it is weighted by market capitalization. Since it has no upper limit on a company’s size, it must always be much more concentrated than the S&P Small-Cap 600 Index and the S&P 400 Mid-Cap Index.
In addition to Zhang’s arguments about the “best of both worlds” in the midcap space, it might surprise you that price-to-earnings valuations haven’t increased anywhere near as much for midcaps (or small caps) as they have for large-cap stocks.
And the same can be said about small caps.
Timothy Skiendzielewski, who manages the Aberdeen U.S. Small Cap Equity Fund /zigman2/quotes/204051293/realtime GSCIX -3.22% , recently made the case that profitable small-cap companies are excellent values in the current market.
Using data compiled by FactSet, here’s a comparison of current weighted forward price-to-earnings ratios for the three broad S&P indexes, showing that the midcaps and small caps aren’t trading at much higher valuations than usual, and that their current discounts to the valuation of the S&P 500 are much larger than usual, based on long-term averages:
|Forward P/E ratios|
|Index||Current||3-year average||5-year average||10-year average||15-year average||20-year average|
|S&P Small Cap 600||15.50||16.43||17.14||16.84||16.42||16.78|
|S&P 400 Mid Cap||18.97||18.78||19.07||18.07||16.99||17.04|
|Percent of S&P 500’s forward P/E valuation|
|Current||3-year average||5-year average||10-year average||15-year average||20-year average|
|S&P Small Cap 600||62%||73%||79%||89%||94%||94%|
|S&P 400 Mid Cap||76%||84%||88%||96%||98%||96%|