In recent times, small-cap stocks have begun to capture significant attention as viable investment opportunities, primarily due to their attractive valuations and emerging secular trends that suggest substantial growth potential. Portfolio managers at Baron Capital, a firm renowned for its early investment in disruptive companies like Tesla, have argued that small-cap stocks are currently underrepresented in investor portfolios. This lack of representation may soon create opportunities for significant gains, especially as interest in this asset class appears to be reaching previously low levels.
Baron Capital’s funds, such as the Baron Growth Fund, Baron Small Cap Fund, and the Baron Discovery Fund, have consistently outperformed their benchmarks while yielding impressive double-digit annualized returns since their inception. According to Morningstar, these funds primarily focus on small-cap companies that exhibit substantial growth prospects. Portfolio manager Laird Bieger emphasized at a recent investment conference that small-cap stocks are the least expensive they have been in the last quarter-century. With total small-cap growth exposure dwindling to a ten-year low, there exists a compelling case for potential investors to reconsider this asset class, creating a ripe environment for contrarian strategies.
The current economic climate may also serve as a tailwind for small-cap companies, as they tend to be more domestically focused and cyclical. The expectations surrounding policy changes under President-elect Donald Trump, including tax cuts and protectionist measures, align well with the strengths of small-cap firms that primarily operate within the United States. Such legislative measures may provide the necessary impetus for these companies to thrive, consequently translating to returns for their investors.
Furthermore, November has seen the Russell 2000 benchmark, a vital indicator of small-cap stock performance, outperforming the larger S&P 500 index. These positive trends provide a backdrop of optimism for portfolio managers, who note that small companies often remain under-researched and overlooked by major wall street analysts. According to Randolph Gwirtzman, another portfolio manager at Baron, the firm conducts thorough research into these smaller entities, often identifying “hidden gems” that others may miss due to their lesser-known status.
Another significant factor driving interest in small-cap stocks is the growth of artificial intelligence (AI). Over the last couple of years, AI has emerged as one of the most exciting themes in investing. In the small-cap space, several companies leverage AI to enhance their offerings, positioning themselves for future successes. For example, Baron highlighted SentinelOne, a company that utilizes AI to bolster its cybersecurity software, ensuring clients maintain fortified network defenses. Similarly, Kratos Defense & Security Solutions employs AI for operating unmanned military jets, showcasing the broad applications of this technology.
Tempus AI, a biotech firm, also garners interest as it utilizes AI for enhancing cancer diagnostic tests and aiding pharmaceutical companies in drug development. By mining extensive cancer data, it aims to deliver crucial insights to the medical field. Investment managers at Baron are also keen on companies in the data-driven business, such as MSCI and Gartner, as the integration of AI into their operations could significantly uplift their pricing structures while enriching the service value they provide.
The landscape of sports betting presents yet another avenue for small-cap growth. One notable example is DraftKings, a gambling platform expected to experience exponential revenue growth as more states legalize sports betting. Baron anticipates DraftKings’ revenue may soar to $3 billion in the next five years—an increase tenfold from current levels—positioning the stock for more than a complete doubling during that same period.
Overall, as small-cap stocks begin to emerge from a prolonged period of investor neglect, the potential for significant returns becomes increasingly attractive. With economic policies favoring domestic growth, the exploration of advanced technologies, and burgeoning markets like sports betting, small-cap companies are positioned for a renaissance. For savvy investors, the small-cap universe may soon provide opportunities that were previously overlooked, making it essential to keep these stocks on their radar.