MW The small-cap rally is real. Here are five stocks to consider owning right now.

By Michael Brush

Why small caps just might be the stock market's new 'Magnificent Seven'

Small-cap stocks should continue to outperform the market - and maybe even lead it.

In a stock market hunting for new leadership, the Russell 2000 Index RUT has advanced about 5% in the past month, outpacing a 1% gain for the tech-heavy Nasdaq 100 NDX, which has been weighed down by weakness among the Big Tech stocks known as the "Magnificent Seven."

Small caps should continue to outperform - and maybe even take the baton from the Magnificent Seven - for several reasons, according to four money managers I recently spoke with. They offered their favorite small-cap stocks, five of which are highlighted below.

1. Fed rate cuts boost small caps: Historically, small-cap stocks do well when the Federal Reserve cuts rates. The stock market is expecting a September rate cut, and Goldman Sachs economist Jan Hatzius is optimistic. In fact, he expects three rate cuts of 25 basis points each in September, October and December, he said, followed by two more next year. Hatzius cited a weak labor market and a decline in consumer spending power for his view.

Hatzius forecast a mere 1% real consumer-spending growth in the fourth quarter. That's a problem because consumer spending drives the economy. In his Jackson Hole, Wyo., speech last week, Fed Chair Jerome Powell said "downside risks to employment are rising" and GDP growth had "slowed notably." Both comments support the Fed rate-cut thesis.

Read: 12 small-cap stocks that should outperform as the Fed cuts rates

2. Small-cap companies have significant innovation-driven potential: Michael Hubbard, senior portfolio manager of the Thrivent Small Cap Growth Fund TSCGX, cited favorable technology trends for small stocks, including an exponential increase in economic and business data, combined with the advent of AI. "Small companies can launch new products faster and more profitably than in the past," Hubbard said in a recent interview.

He said that large companies do not have the same advantages, owing to bureaucratic inertia and their status quo buy-in - the so-called innovator's dilemma. As evidence, Hubbard noted that large incumbents are getting disrupted faster. Large S&P 500 SPX companies typically last seven years in the index, compared with about 60 years in the 1950s.

3. Small caps are a real bargain: These stocks are extremely cheap relative to large-cap stocks. The S&P 600 SML, for example, trades at a forward price-to-earnings ratio of 16 compared with 23 for the S&P 500. Put another way, the market value of small caps is currently about 5% of the value of all stocks. That's a low seen only a few times since the Great Depression, Perritt Capital Management small-cap money manager Michael Corbett said in a recent interview.

Corbett offered this relative-performance chart of the Ibbotson U.S. Small Stock Index to the S&P 500. "If history repeats or rhymes with the past, the forward relative performance for small-caps should be strong," Corbett said. When small caps start outperforming, the trend typically continues for a while.

Source: Perritt Capital Management

5 small stocks with big potential

1. LandBridge Co. LLC (LB): Kinetics Small Cap Opportunities Fund KSCOX manager James Davolos said he favors companies that benefit from lower interest rates - such as companies in the energy sector, which also benefit from the deregulation efforts of the Trump administration.

Davolos is worth listening to because his fund beats the benchmark Morningstar small-cap index by more than six percentage points annualized over the past three years, and even more over five years, according to Morningstar Direct.

"If the Fed brings rates down, the cyclical hard-asset companies would lead," Davolos said in a recent interview. "They are also some of the cheapest companies because of worries about the economy."

LandBridge, his fund's second largest holding as of the end of June, leases land in the Permian Basin in Texas to energy companies, which use it to dispose of wastewater produced in fracking. It's increasingly difficult for energy companies to dispose of wastewater near their wells because it can disrupt production. Demand for LandBridge's land will increase as wells age, because older wells produce more wastewater, he said.

2. Millrose Properties Inc. (MRP): Homebuilders are turning to an "asset light" business model to boost return on capital by moving land off the balance sheet. Millrose's business helps them accomplish this. Millrose buys and develops residential land from home builders, then sells finished homesites back to them via option contracts. Think of it as a land bank.

Bob Robotti of Robotti & Co. Advisors added this stock as a new position in the second quarter. Robotti's stock picks often outperform over the long run. In the past five years, the Robotti Value Equity Composite has outperformed its Russell 2500 Value Index benchmark by 7 percentage points, annualized. It has also outperformed since its inception in 1993.

Millrose Properties will do well as both home builders and stock investors get comfortable with the business model and the predictability of the company's yield, Robotti said in a recent interview. Millrose is a real-estate investment trust that offers an 8% yield. The company was spun off from Lennar Corp. $(LEN)$ last February.

3. Triumph Financial Inc. $(TFIN)$: This bank is a good example of a small company using innovation to get ahead, according to Hubbard, the Thrivent fund manager. Besides traditional banking, Triumph offers factoring. That means it buys accounts receivables - or invoices - from truckers who want to collect in advance. Triumph has an edge because it has developed algorithms to detect fraud, Hubbard said. Last year, the company also launched a "factoring as a service" platform to handle back-office factoring services for the trucking industry. It also offers a payments network. "They have fintech within a bank, and they did it profitably without diluting shareholders," Hubbard said.

4. Agilysys Inc. $(AGYS)$: Agilysys offers property- and payment-management software for hotels and restaurants. Hotel giant Marriott International Inc. $(MAR)$ recently signed on as a customer.

The key for Agilysys is that its business is cloud-based. The company's software was built from the ground up to operate in the cloud. "That makes it cheaper to run," Hubbard said. "They don't need people on premise. They can push new features faster." Meanwhile, the competition - legacy vendors - moves existing code into the cloud, which means their systems are less flexible and reliable, Hubbard said.

5. Lincoln Educational Services Corp. $(LINC)$: As many parents balk at the high cost of a traditional college education, trade schools such as Lincoln Educational Services are being seen as a viable option. The company offers training to prepare for jobs in healthcare, auto mechanics and welding, among other trades, at its 21 campuses in 12 states.

Recently, the stock fell 16% to trade at around $20 a share after it posted second-quarter earnings. But the quarter wasn't terrible. Revenue grew 13% on 16% student population growth, and the company raised its earnings guidance. Yet the stock trades at just a little over one times sales, which Corbett at Perritt Capital Management said is cheap given the company's growth.

Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush writes a stock newsletter, Brush Up on Stocks. Follow him on X @mbrushstocks.

      Also read:   Why the Russell 2000 has a real chance to beat the S&P 500 - finally 

More: Small-cap stocks have finally busted out of a range

-Michael Brush

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

August 30, 2025 12:41 ET (16:41 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.