In the world of investing, small-cap stocks have long been overshadowed by their larger counterparts, often viewed as high-risk, high-reward entities that exist on the fringes of mainstream investment strategies. However, recent insights from portfolio managers at Baron Capital suggest that these underappreciated stocks are poised for a significant comeback. With current valuations appearing more attractive than they have been in a quarter-century, and with beneficial macroeconomic trends on the horizon, the case for small-cap stocks is not just compelling; it is urgent.
Baron Capital has established itself as a key player in the small-cap investment landscape, building a reputation through early investments in household names like Tesla. The firm’s dedication to the small-cap sector is reflected in its funds—the Baron Growth Fund, Baron Small Cap Fund, and Baron Discovery Fund—each of which has achieved impressive double-digit annualized returns. Portfolio manager Laird Bieger emphasizes the current state of small-cap stocks, pointing out that “they are the cheapest they have been in the last 25 years.” This observation is striking, particularly in a market where larger companies often garner more attention and investment, creating a landscape ripe for contrarian strategies.
Investors are currently reducing their exposure to small-cap stocks, pushing their total growth exposure to a ten-year low. This shift may reflect a broader trend of risk aversion, but it also suggests a potential opposite outcome—contrarian investors may find themselves stepping into a market where future gains are highly probable. Such a scenario positions small caps as a captivating opportunity for those willing to take a calculated risk.
Established in the 1990s and enhanced with a later fund in 2013, Baron’s suite of small-cap funds is notable for its consistent outperformance against their respective benchmarks. According to data from Morningstar, this ongoing success directly ties back to the deep research conducted by Baron’s investment team. Randolph Gwirtzman, another portfolio manager at Baron, stresses the undervaluation of small companies, which often go unnoticed and under-researched by larger institutional investors. This allows Baron to identify “hidden gems”—the small companies equipped to emerge as market leaders due to unique competitive advantages.
Moreover, the economic landscape under President-elect Donald Trump, characterized by tax cuts and protectionist policies, is set to benefit small-cap companies, which are typically more domestically focused and cyclical in nature. With the Russell 2000 index demonstrating a commendable performance against the S&P 500, small-caps are increasingly becoming the talk of the investment community.
An intriguing dimension of small-cap growth potential lies in the adaptive capabilities of these companies, particularly concerning technological advancements such as artificial intelligence (AI). Baron Capital has identified several small-cap firms that are at the forefront of utilizing AI to enhance their offerings. For instance, SentinelOne, a cybersecurity firm, leverages AI to fortify its software, while Kratos Defense & Security Solutions incorporates AI in military drone operations. Biotech firm Tempus AI also stands out by using AI to revolutionize cancer diagnostics, exemplifying how small entities can harness technology to disrupt and dominate their respective industries.
Additionally, the growing data-driven economy presents unique opportunities for small-cap firms. Companies involved in data analytics and sports betting, such as DraftKings, represent sectors that are thriving amid increasing legalization and technological integration. With expectations of DraftKings’ revenues potentially escalating tenfold, the future growth trajectory seems remarkably promising.
The current landscape indicates that small-cap stocks may be on the brink of a renaissance, underscored by attractive valuations, a favorable economic policy environment, and the transformative power of technology. Investors willing to explore this sector may uncover significant opportunities that have been overlooked. As Baron Capital demonstrates through its focused research and strategic selections, a renaissance in small caps may not just be a possibility; it may become an investment reality for those prepared to act. As the market ecosystem evolves, small-cap stocks are increasingly capturing attention, offering both potential growth and diversification for forward-thinking investors.