We expect small-cap earnings growth could exceed that of large-cap stocks in 2025, aided by easier earnings comparisons.
Small-cap valuations – Attractive
We expect earnings to drive the next leg higher for small-cap share prices. Analysts are looking for robust earnings growth: 15% this year, and by over 30% in 2025 and 2026. That is ahead of the long run rate of 13% growth (see Exhibit 3).
Small-cap funds are riskier than large-cap funds and may not be suitable for everyone. Small-cap companies are more sensitive to market changes and can experience sudden and wide price fluctuations. Small-cap companies are less popular and smaller in size, making their stock less liquid.
Small-caps are making a comeback in 2024, with the Russell 2000 index up 17% this year, though it still lags the S&P 500.
Given the changing macroeconomic backdrop, we outline why we see potential value for investors in small caps in 2024. The consensus is that interest rates look to have peaked, with markets now pricing in cuts across many major economies in 2024, something which could prove beneficial to small caps.
If you can invest in a small-cap stock that has good fundamentals and an overall healthy analysis, the stock will most likely grow over the long term. If you can invest before a bull run on the market and hold the stock for the long term, then you could see a strong financial return.
The mid-cap and small-cap segments have been standout performers in the Indian equity market in 2024. The NIFTY Midcap 150 and NIFTY Smallcap 250 indices have delivered impressive year-to-date returns of approximately 18% and 25%, respectively, as of December 2024.
Short-Term Investor. If you are investing in mutual funds for a short duration, stay away from small-cap mutual funds. Small-cap mutual funds perform well over a long period of time. However, over a short period of time, they tend to be very volatile.
Most investors think smaller companies underperform in a recession. In most cases, they are correct. However, what's less well-known is that small caps usually exit recessions quicker than assumed – outperforming large caps. This rebound can begin as early as three months into an economic downturn.
2025 outlook: Small caps offer an inexpensive way to gain exposure to the robust US economy. Multiple favorable trends – including onshoring and increased CAPEX – may explain why Wall Street expects to see the strongest earnings gains come from small caps in 2025.
The small cap segment can be extremely volatile in the short term, but they have the potential to offer very high returns over a long period. Small cap schemes are recommended only to aggressive investors with a high-risk appetite and long investment horizon, say, around seven to 10 years.
Several factors have contributed to small-cap underperformance, including (1) a decline in the average quality of companies included in small-cap indexes, (2) the greater rate sensitivity of small-cap stocks during a period of tighter monetary policy, and (3) muted M&A activity, which otherwise tends to benefit small- ...
High Returns: Small Cap mutual funds have the potential to provide significantly higher returns than mid-cap or even large-cap funds. This is due to the strong growth potential of these companies.
As of October 19, 2024, the small cap index was overvalued at a Price-to-Earnings (P/E) of 33.39, while the 3 year long term average stands at 24.49. But experts think there are certain sectors within the small cap that are fairly valued.
However, numerous small-cap stocks do not have the capacity to handle exceptionally large trading volumes. In other words, small-cap stocks can face liquidity constraints. Small Cap Mutual Funds also find it challenging to invest the inflows worth crores they are getting each month amid stretched valuations.
Market experts recommend that investors hold small caps for at least 10 years to benefit and allocate 8% of the portfolio to small caps.
The overall quality of publicly traded small caps has deteriorated, as private sponsors help top performers stay private for longer. Instead of small caps, investors should consider actively adding exposure to U.S. large-cap value and mid-cap growth stocks.
In July 2024, U.S. small-cap stocks outperformed large-cap stocks after lagging for the first half of the year, driven by a cooler inflation report and improved market sentiment.
Looking ahead, S&P 500 stocks are currently forecast to generate 13% EPS growth in 2025 and 13.1% growth in 2026 (versus 8.5% EPS growth in 2025), while the S&P SmallCap 600 Index is currently forecast to generate EPS growth of 20.9% in 2025 and 18.6% EPS growth in 2026 (versus minus 8.0% EPS growth in 2024), according ...
If economic growth continues to be strong, the earnings of small-cap companies could exceed those of large-cap companies beginning in 2025. Not only are fundamentals expected to improve during this period, but this strength is also anticipated to align with the Fed's easing cycle.
Investing in small caps during recessions has generated superior investment returns, according to our back-testing of the data to the late 1980s (see Table 1, below).
Small-Cap Stocks Outlook for 2025
Lee pointed out that 2025 is going to be a good year for small and mid-cap stocks. Backed by interest rate cuts and the incoming administration, companies are going to be expansionary and feel confident about mergers, added Lee.
Small-cap is not a bad thing, it is just that you should have the time-frame. If you're investing for any 10 year, small-cap will beat all other kinds of funds hands down, but if you are coming with a very short-term expectation, you will be very surprised in a very negative way.