By Jason Zweig

Will small stocks stink forever?

Little companies are supposed to earn higher returns over time than big ones, but that hasn't been the case for more than a decade. Since the beginning of 2014, the S&P 500 has grown at an average of 13.2% annually; the Russell 2000 index of small stocks has gained just 7.2%.

Many people seem to be throwing in the towel. So far this year, investors have pulled $12 billion out of exchange-traded funds investing in small U.S. stocks, according to FactSet. Meanwhile, investors added $149.6 billion to ETFs that track large U.S. companies.

Money always chases performance, and big stocks have all the momentum -- burnished by the artificial-intelligence boom. But what if AI turns out to be a bust, it fails to meet expectations or the biggest stocks end up stagnating? Then investors who didn't give up on smaller stocks will be rewarded.

Let's start by reviewing just how far small stocks have fallen out of favor.

The market value of the five biggest companies in the S&P 500 is nearly five times the combined market value of the Russell 2000 index, according to Steven DeSanctis, an equity strategist at Jefferies. In fact, Nvidia alone -- at its recent market value of $4.22 trillion -- is 65% more valuable than all the stocks in the Russell 2000 combined.

The 6.6% annualized total return on small stocks over the past 10 years trails large-company performance by 7.3 percentage points, says DeSanctis. (All figures include dividends.)

That's the widest gap going back to 1935.

Much of that underperformance comes from underexposure to this market's hottest sector. Technology firms constitute nearly 34% of the total capitalization of the S&P 500. In the Russell 2000 and the S&P SmallCap 600, another widely followed index, tech companies make up less than 13% of total value. Financial stocks are the biggest sector in both those benchmarks, at about 19%.

With investors going ga-ga for anything that even seems related to tech and AI, little stocks have been left in the lurch.

The tech-dominated titans in the MSCI USA Mega Cap Select Index are trading at an average of 30.4 times net profits and nearly eight times net worth. The Russell 2000 trades at 18.3 times earnings and two times net worth.

Big tech companies "have a lot of speculation built into them, so there's not a lot of room for error," says Christine Wang, a portfolio manager at Bridgeway Capital Management in Houston.

"They would be severely punished for not meeting expectations."

Smaller stocks, on the other hand, have gotten so cheap relative to the market's giants that "even if you fall from here," says Wang, "you're only falling out of a one-story house now."

Thomas Cole, co-founder of Distillate Capital Partners in Chicago, points out a key difference between this technology boom and the last one, in the late 1990s. "This time, investors are putting extraordinary premiums on established businesses" rather than only on new ventures. Meeting expectations "becomes a much taller order," he says, when companies are already huge.

It's worth remembering, too, that most of the beneficiaries of the internet boom weren't the online providers but rather the consumers: manufacturers, healthcare, service and materials companies that used the emerging technology to streamline their own operations. If the AI boom unfolds the same way, smaller companies could get a bigger boost than the giants.

History suggests that if the market's biggest companies do stumble, the little guys might do reasonably well.

From 2000 through 2002, in the bear market that followed the collapse of the internet boom, the S&P 500 lost 37.6%. The Russell 2000 fell much less, losing 21%, while the S&P SmallCap 600 even squeaked out a 1.7% cumulative gain.

In 2008, the worst year of the global financial crisis, the S&P 500 fell 37%. The Russell and S&P small-stock indexes lost 34% and 31%, respectively.

What's more, if the trade war ends up hurting the international sales of U.S. businesses, small stocks should suffer less. They derive an average of 20% of their revenues from overseas, substantially below the 28% average for the S&P 500, according to Goldman Sachs.

Professional investors love to cite data showing that from 1926 to the present, little stocks outperformed large by an average of roughly 2 percentage points annually.

That's a huge margin, but it's probably overstated. In decades past, brokerage costs were much higher on smaller stocks, and the tiniest companies traded so infrequently that a single buy order could send their prices soaring.

What we can be sure of is that small stocks are cheap relative to the market's much more popular giants. No one can say when that might change, but you don't want to miss it when it does.

So you shouldn't be dumping small stocks. Nor should you yank all your money out of big companies to put it into small ones. But keeping 5% to 10% of your stock portfolio in smaller companies is a good idea -- now more than ever.

Write to Jason Zweig at intelligentinvestor@wsj.com

(END) Dow Jones Newswires

July 18, 2025 10:00 ET (14:00 GMT)

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