Small-cap stocks are finally showing signs of life. After trailing large caps for much of the past decade, the Russell 2000 has returned nearly 25% since the market bottomed out in April, outpacing the S&P 500. Even though it’s only been a few months, investors are beginning to ask whether the small-cap rebound has legs. With the Federal Reserve signaling that interest rate cuts could be on the horizon, small caps may have a tail wind as credit conditions ease and growth potentially picks up. If a small-cap regime is truly taking hold, investors are beginning to ask how best to capitalize on the shift.
Most investors today are heavily allocated to the Magnificent 7 and other large-cap tech names. While that concentration has worked in recent years, it also leaves portfolios vulnerable if leadership broadens out or mega-cap growth cools. That’s where strategies focused on smaller, lesser-known companies can play a valuable role as diversifiers — though it’s important to acknowledge that these approaches are riskier, often concentrated, and more volatile than simply owning the index.
The Motley Fool Small-Cap Growth Approach
Validea’s Motley Fool Small-Cap Growth Investor portfolio is based on the strategy laid out by David and Tom Gardner in The Motley Fool Investment Guide. The Gardners emphasized finding fast-growing small companies with strong fundamentals, including:
- Profitability — at least 7% after-tax margins
- Insider ownership — management stakes above 10%
- Cash flow generation — not just accounting profits
- Reasonable valuations — a PEG (or “Fool Ratio”) below 0.5
- Strong Momentum — stocks with a relative strength of 90 or better are top of the food chain
This methodology seeks “hidden gems” — profitable, smaller businesses that could grow into much larger enterprises over time.
Results and Risks
Since 2003, the strategy has returned 1,722% vs. 552% for the S&P 500, a 14.0% annualized gain compared to 8.8% for the S&P 500 index. But the outperformance has come with volatility. The portfolio dropped 27% in 2008 and more than 30% in 2022 — a reminder that concentrated small-cap growth strategies can cut both ways.
The flip side is explosive upside when conditions align. In 2020, the portfolio gained 106.5%, followed by another 51.7% in 2021. For investors who can stomach the swings, it has historically been a powerful source of returns.
Today’s Top Small-Cap Growth Stocks
As of today, the highest-scoring names in Validea’s Motley Fool Small-Cap Growth model include a diverse set of small-cap businesses:
| Ticker | Company | Score | Price | Market Cap ($M) | P/E | EPS Growth | Yield | Rel. Strength | Shareholder Yield |
|---|---|---|---|---|---|---|---|---|---|
| ITRN | Ituran Location & Control | 87% | $36.35 | 731 | 13.2 | 36.9% | 5.1% | 73 | 5.2% |
| CCRD | CoreCard Corp | 87% | $27.69 | 214 | 27.8 | -3.4% | 0.0% | 90 | 3.2% |
| XYF | X Financial (ADR) | 85% | $14.98 | 863 | 2.8 | 22.6% | 0.0% | 95 | N/A |
| ASA | ASA Gold & Precious Metals | 83% | $36.94 | 702 | 5.0 | 27.2% | 0.1% | 95 | -16.8% |
| YALA | Yalla Group Ltd (ADR) | 83% | $7.87 | 1,051 | 9.8 | 34.2% | 0.0% | 90 | N/A |
| XNET | Xunlei Ltd (ADR) | 83% | $6.68 | 422 | 0.6 | N/A | 0.0% | 96 | -0.7% |
| HCI | HCI Group Inc | 83% | $163.79 | 2,098 | 14.3 | 117.0% | 1.0% | 87 | -7.4% |
| NAGE | Niagen Bioscience Inc | 83% | $9.76 | 801 | 46.9 | N/A | 0.0% | 94 | -5.7% |
| ESQ | Esquire Financial Holdings | 80% | $100.36 | 858 | 18.6 | 30.5% | 0.6% | 86 | -1.1% |
| USLM | United States Lime & Minerals | 80% | $124.52 | 3,482 | 27.9 | 41.7% | 0.2% | 85 | 3.8% |
These companies range from niche tech and financial names to gold, minerals, food producers and non-US firms — reflecting the strategy’s willingness to venture into overlooked corners of the market.
Bottom Line
If small caps continue their rebound, strategies like the Motley Fool Small-Cap Growth model could benefit by identifying strong businesses outside the mega-cap universe. While risky and concentrated, they offer investors a way to diversify away from the dominant large-cap growth trade and potentially uncover tomorrow’s big winners while they’re still flying under Wall Street’s radar.
