In recent months, small-cap stocks have been gaining attention from investors who are seeking value amid fluctuating market conditions. Portfolio managers at Baron Capital argue that these stocks may be on the cusp of significant growth, driven by attractive valuations and emerging secular trends. Baron Capital is renowned for its early investments in high-growth companies like Tesla and maintains a strong focus on the small-cap sector through its funds, such as the Baron Growth Fund, Baron Small Cap Fund, and Baron Discovery Fund, all of which boast impressive annualized returns and consistent outperformance compared to their benchmarks.
The excitement surrounding small-cap stocks is noteworthy—these stocks are experiencing their lowest levels of investor ownership in decades. Laird Bieger, a portfolio manager at Baron Capital, pointed out during a recent conference that small caps are currently being viewed as undervalued, with the market sentiment potentially indicating a turning point. This under-ownership might serve as a contrarian signal, suggesting that the future performance of small-cap stocks could surprise investors positively.
Historically, small-cap stocks have performed well during periods of economic expansion. They tend to be more domestic-oriented and sensitive to economic cycles, making them positioned to capitalize on favorable economic policies. For instance, the anticipated tax cuts and protectionist measures proposed by recent administrations can result in a beneficial environment for smaller companies that primarily operate within the U.S. economy. Interestingly, the Russell 2000 index, which tracks small-cap stocks, has shown resilience, outperforming larger indices like the S&P 500 by a notable margin.
Baron Capital’s funds, having navigated various market conditions since their inception in the 1990s, reflect a commitment to diligently researching these lesser-known companies. Randolph Gwirtzman, another portfolio manager, emphasized the advantages of their in-depth research approach, which identifies companies that might otherwise fly under the radar. By focusing on these businesses, portfolio managers can discover ‘hidden gems’ that are primed for growth but have not yet attracted significant market attention.
One of the most dynamic trends within small-cap stocks is the integration of artificial intelligence (AI) across various sectors. Baron Capital has highlighted several companies that leverage AI to improve their competitive positioning and product offerings. For example, SentinelOne has emerged as a frontrunner in cybersecurity by utilizing AI to bolster its software solutions, safeguarding client networks with advanced threat detection capabilities. Similarly, Kratos Defense & Security Solutions is redefining military operations with its AI-enabled unmanned systems.
In addition to technology and defense sectors, biotechnology firms are also capitalizing on AI advancements. Tempus AI, for example, is incorporating machine learning to enhance cancer diagnostics, while also maintaining an extensive database that aids pharmaceutical companies in drug development. This innovative approach highlights how small-cap companies can utilize cutting-edge technology to disrupt traditional industries and capture market share.
The trend of limited investor interest in small caps does not mean that all areas are underperforming. The rise of sports betting platforms, such as DraftKings, signifies a burgeoning market that could see substantial growth as more states legalize gambling. According to Baron Capital’s projections, DraftKings’ revenue could skyrocket to $3 billion within five years, marking a tenfold increase from current figures. This potential for exponential growth places such companies firmly on investors’ radars.
Additionally, firms engaged in proprietary data that utilize AI to enhance their services are gaining momentum as their ability to drive insights becomes increasingly valuable. Companies like MSCI and Gartner are positioned to benefit from these technological advancements, enabling them to extract greater value from their data and adjust pricing accordingly.
The narrative surrounding small-cap stocks presents a compelling case for cautious optimism. While challenges remain, the current environment offers opportunities for investors willing to adopt a contrarian stance. With profound research backing the selection of promising companies and an emerging focus on technology and innovative practices, small-cap stocks could very well be on the verge of a resurgence. As always, potential investors should weigh their options carefully and consider how these stocks fit into their broader investment strategy.