3 Small Cap Restaurant Stocks to Watch When Rates are Cut

Even if the Federal Reserve (the Fed) pushed back its date on potential interest rate cuts for 2024, markets today seem more focused on being right rather than making money. The initial expectation was set for four rate cuts starting in March 2024. After the Fed’s most recent speech, that timeline looks more like one cut for November, if that.

According to the CME’s FedWatch tool, there is currently a 61.1% probability of the Fed making a 25 basis point rate cut in its September 18th FOMC meeting. However, the Fed is not putting its money where its proverbial mouth is. Following the latest Fed balance sheet release, up to $3.6 billion worth of U.S. treasury securities (bonds) were dumped by the Fed itself, which isn’t indicative of rate cuts.

More than that, the overall balance sheet has been on a steady decline since April 2023, decreasing the likelihood of any cuts coming soon. Investors can get behind a relatively failproof plan to beat the market when and if these cuts come, no matter the timing, and that’s by backing small capitalization stocks in the consumer discretionary sector, names like Dine Brands Global Inc. (NYSE: DIN), beloved Denny’s Co. (NASDAQ: DENN), and even B&G Foods Inc. (NYSE: BGS); here’s why.

Should You Follow Stanley Druckenmiller's Interest in Small Cap Stocks?

Reportedly, Stanley Druckenmiller – once operating shoulder to shoulder with George Soros – sold out of Nvidia Co. (NASDAQ: NVDA) and is now eyeing small-cap stocks within the iShares Russell 2000 ETF (NYSEARCA: IWM). There’s a good reason behind it.

This ETF has only performed 6.9% in the past 12 months, while the S&P 500 reached new all-time highs with its 24.2% run in the same time span.

Because small-cap stocks tend to historically outperform the rest of the market during low interest rate periods, Druckenmiller may be looking to call the coming cycle as accurately as possible.

However, not every small-cap stock is made equal; smaller investors should focus on healthy cash-flowing businesses that are trading at deep enough discounts for them to consider in their wealth-compounding campaigns, and these three fit the description.

Dine Brands: Delivering Cash Flow in All the Ways That Matter to Investors

This company’s financials show a free cash flow (operating cash flow minus capital expenditures) of $121.1 million in the past 12 months. This is good enough to boost the stock’s attractive 5.5% annual dividend yield today.

But more than that, here’s how the company’s history could set it up to beat the rest of the market when and if rate cuts come. Over the past five years, this free cash flow metric has grown at a compounded average growth rate (CAGR) of 7.2%, making today’s valuation as attractive as it’s been.

With a market capitalization of only $572 million, the stock trades at a price-to-free cash flow multiple of 5.4x, making it one of the cheapest deals in the small-cap world. Knowing that this healthy free cash flow is at a discount today, analysts at Truist Financial saw it fit to boost the stock’s price target to $74 a share, daring it to rally by nearly 100% from today’s price.

Denny's ROIC Turns Cash Flow Golden In Current Valuations

Showcasing a gross margin of nearly 40% in its financials, Denny’s management can deploy more capital in ways that bring shareholders another reason to stick to this stock as a potential value play for the small-cap return sponsored by eventual rate cuts.

The company’s return on invested capital (ROIC) rate stands above 10%, which would make young Warren Buffett jump on one leg after realizing how cheap this profit stream is selling for today.

Free cash flow at Denny’s has not grown by much in the past five years. Still, it has remained steady between $40 million and $70 million, indicating predictability and stability. Considering the company’s $339 million market capitalization, it trades at 8.9x its five-year average free cash flow, another cheap stock to add to this small-cap list.

Piper Sandler analysts used these metrics to justify Denny's stock's current $12 a-share price target. This ceiling is 84.6% above today's stock price, a mere 47.2% of its 52-week high.

B&G Stock: A Prime Example of Buffett's Cigar Butt Investment Strategy

This company is now giving investors potentially the best deal in this list, befit of Buffett’s ‘cigar butt’ strategy, which involves buying a company that is not necessarily that awesome but is cheap enough to give its investors one last push.

Looking at its financials, B&G stock is now trading at only 4.8x free cash flow while still pumping a gross margin rate of 22.4%, which is still up to the industry standard.

On a price-to-book (P/B) basis, B&G stock trades at a discount to its book with a multiple of 0.8x. Compared to the rest of the food industry, which trades at a P/B of 3.9x, investors now face a discount of 79.5% to peers in the space.

Knowing that the historical record is now against them, short sellers started to bail on the stock recently, as B&G stock’s short interest has declined by 5.6% in the past month.

The article "3 Small Cap Restaurant Stocks to Watch When Rates are Cut" first appeared on MarketBeat.