Why Archer Aviation Is My Highest-Conviction Small-Cap Stock

While large-cap growth stocks have dominated the U.S. market since the Federal Reserve began hiking interest rates in March 2022, the tide may soon turn. With the central bank poised to start cutting rates later this year, we could see a broader rally in mid- and small-cap growth equities.

Which growth stocks should investors have on their radar leading into this potential catalyst? One stock that has my attention right now is Archer Aviation (NYSE: ACHR) , a top contender in the ultra-high-growth electric vertical take-off and landing (eVTOL) aircraft space.

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Archer's stock has skyrocketed by nearly 57% over the past 30 days, leaving the S&P 500 's 3.58% gain in the dust. Despite this eye-popping surge, I believe Archer remains significantly undervalued. And Wall Street appears to share my optimism. At current levels, analysts think the stock still has a noteworthy 81% upside potential over the next 12 months.

Here's why this eVTOL stock has become my highest-conviction pick in the small-cap growth landscape heading into the second half of 2024.

The urban air mobility revolution

The urban air mobility (UAM) movement, powered by low-noise, green eVTOL aircraft, addresses two pressing urban issues: traffic congestion and pollution. By replacing 20-mile commutes with short-duration flights, UAM offers a compelling solution to these growing problems.

While near-term growth may be tempered by slow adoption rates, the eVTOL market is projected to rise at a stellar 15.3% compound annual growth rate from 2023 to 2030. Beyond that, investment bank Morgan Stanley anticipates explosive growth, with the total addressable market potentially reaching a staggering $1 trillion by 2040.

Now, this enormous opportunity hasn't gone unnoticed, with over 230 companies worldwide vying for a piece of the eVTOL pie. However, the harsh reality is that most lack the substantial financial resources needed to design, build, and certify a world-class eVTOL aircraft.

This financial hurdle is reflected in the poor performance of eVTOL stocks overall. Since their IPOs, companies with market caps above $200 million have seen an average return on capital of negative 59% and have diluted their share count by an average of 53% to fund their enormous capital expenditures (author's data).

Archer's competitive edge

Archer Aviation, however, stands out from the crowd. Through its strategic partnership with automaker Stellantis (NYSE: STLA) , Archer has implemented a "capital light" approach to developing its production aircraft, dubbed "Midnight." Designed as a durable, larger-than-normal eVTOL capable of regular short-duration flights in urban environments, Midnight could see commercial operations as early as next year.

Stellantis plays a crucial role in Midnight's development, holding a 22% equity stake in Archer and serving as the company's contract manufacturing partner. This collaboration enables Archer to produce the vehicle at scale post-certification, giving it a significant edge over many competitors.

Key takeaways

As the bull market expands beyond U.S. large-cap stocks in response to the upcoming rate cuts, I suspect Archer's shares will become a prime target for investors due to the dynamic outlined above. Moreover, for those willing to hold for the long term -- think 15 to 20 years -- Archer's stock has the potential to deliver Nvidia -like returns, thanks to the key problems its platform addresses.

Of course, there's much more to this story than can be conveyed in a short article. The eVTOL market is complex and evolving rapidly, with significant challenges -- such as certification and building the infrastructure to support commercial flights -- on the near-term horizon. However, Archer's strategic partnerships, capital-efficient approach, and innovative aircraft design position it as a top contender in this high-growth industry.

George Budwell has positions in Archer Aviation. The Motley Fool has positions in and recommends Nvidia. The Motley Fool recommends Stellantis. The Motley Fool has a disclosure policy .