Fed Rate Cuts Could Lead to Big Gains for Some Smaller Stocks. Here are a Few

Small-cap stocks are poised to benefit significantly from the Federal Reserve's latest rate-cutting campaign, as the central bank's decision to reduce interest rates by a substantial half-percentage point has lifted the stock market. The Fed’s move boosted broader market indices, with the S&P 500 ending the week with a 1.4% gain, recovering from earlier losses in September. Similarly, the Dow Jones Industrial Average rose by 1.6%, and the Nasdaq Composite gained 1.5% over the week.

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Although lower interest rates can benefit the economy as a whole, small-cap stocks tend to gain even more, primarily because many of these companies rely heavily on floating-rate debt and bank loans. With lower interest rates, it becomes cheaper for these businesses to refinance their debt, enhancing their profitability. This optimism surrounding small-cap stocks was evident, with the Russell 2000 index—a benchmark for small-cap equities—rising by 2.1% in the past week.

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To identify stocks that might outperform under these conditions, CNBC conducted a screen for small-cap stocks with high debt loads that are likely to benefit from lower rates. The criteria for selection included being part of the S&P MidCap 400 or the S&P SmallCap 600 indexes, receiving buy ratings from at least 60% of analysts covering the stock, having an upside potential of at least 30% relative to consensus price targets, and carrying a total debt of at least 70% of equity.

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One standout from this analysis is Sarepta Therapeutics, a biotechnology company that has already gained 32% in 2024. Sarepta, based in Cambridge, Massachusetts, is well-regarded by analysts, with four out of five rating it a buy. The company’s total debt is more than 1.5 times its equity, making it a strong candidate to benefit from lower interest rates. According to consensus estimates, Sarepta’s stock has a potential upside of 52.5%.

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Sarepta’s recent success can be attributed to its gene therapy product, Elevidys, designed to treat Duchenne muscular dystrophy. Evercore ISI recently upgraded the stock to outperform, with analyst Gavin Clark-Gartner citing the stock’s weakness as an opportunity to buy. He noted that although Elevidys’ ramp-up won’t be fully realized until 2025 or later, the stock is well-positioned for future gains. Clark-Gartner set a price target of $179 for Sarepta, which represents a 41% increase from its recent close.

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Another small-cap stock that is drawing attention is Civitas Resources, an energy producer that has struggled in 2024, with its stock down 21% year-to-date. Despite this decline, analysts remain bullish on Civitas, with 94% of them issuing buy ratings. On average, analysts predict an upside of more than 52% for the stock, which is bolstered by a debt level that stands at 79% of the company’s equity.

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JPMorgan’s Zach Parham recently initiated coverage of Civitas with an overweight rating, assigning the stock a $67 price target. This implies a potential rise of 23% from its current price. Parham believes Civitas is currently trading at a discount compared to its peers, which he views as an excessive punishment given recent changes to the company’s capital return program. Civitas has shifted its focus toward share buybacks, a move that Parham expects will drive the stock’s valuation higher.

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A third small-cap stock with significant upside potential is Chart Industries, a manufacturer of engineering equipment for the energy sector. Despite a 10% decline in its stock price this year, analysts are optimistic, with 74% of those covering the stock issuing buy ratings. Chart’s debt is also notable, as it exceeds its equity by 1.4 times, making the company another strong candidate to benefit from a lower-rate environment. Analysts see an average upside of 49% for the stock.

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Chart Industries received an upgrade from Morgan Stanley last week, with analyst Devin McDermott raising the stock’s rating to overweight. McDermott highlighted the company’s core portfolio, which is heavily focused on natural gas, energy transition, and renewable energy applications. He noted that these markets have a constructive outlook, making Chart Industries an attractive investment opportunity. McDermott set a price target of $175 for the stock, suggesting a 43% increase from its recent price.

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As the Federal Reserve embarks on a rate-cutting cycle, small-cap stocks stand to benefit significantly. Many of these companies carry substantial debt, which becomes easier to manage with lower interest rates. Investors seeking opportunities in this environment are focusing on stocks with high debt loads and significant upside potential, as they are likely to experience outsized gains in the months ahead. Sarepta Therapeutics, Civitas Resources, and Chart Industries are just a few examples of small-cap stocks that have caught the attention of analysts and investors alike.

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With lower rates providing relief for debt-laden companies, small-cap stocks may be poised for outperformance, especially as the Fed continues to adjust its policies to support the broader economy.

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