It’s time for the minnows to make a splash! In recent years, investors have abandoned small-cap stocks. Slammed by fast-rising interest rates, high inflation and the likelihood of a recession, small companies with market capitalizations of $2 billion or less just seemed too risky and volatile compared with much larger, cash-rich businesses.

But stock expert Douglas Gerlach says 2025 is the year small-cap stocks may finally take off and could even assume long-term market leadership. Here’s why: Valuations are cheap. The S&P SmallCap 600 index’s price-to-earnings ratio (P/E) is well over 25% less than that of the pricey S&P 500 index—that’s the largest gap since the late 1990s. Plus, the prospect of multiple interest rate cuts by the Federal Reserve is a powerful tailwind for small-cap stocks and their companies because it lowers their borrowing costs and they rely much more on loans than larger companies. In fact, small-cap stocks have historically gained an average of 27% in the first year after the start of an interest rate cut versus 16% for large-caps. 

Bottom Line Personal asked Doug Gerlach how he uncovers the best small-cap stocks without the drama and risk, as well as his favorite ones now….

Finding Winning Small Companies

Investors have a love-hate relationship with small-cap stocks. Their potential for growth is greater than many larger companies, but the wide up-and-down swings in share prices can lead to these two investment mistakes…

Gravitating toward companies with big, exciting stories…but no profits. Pay less attention to headlines and the potential to change the world and more attention to balance sheets. There are thousands of small-cap stocks to choose from, so eliminate those that are losing money.

Overpaying for shares. One of the best pieces of advice I ever heard was that buying a stock with a P/E of more than 25 was discounting not only the future, but the hereafter as well! Small companies often are attractive because of their rapid growth rates, but fast growth tends to command a premium price—but only if the company continues to produce outstanding growth year after year. That’s a tall order.  

Here’s what I look for to limit risk and volatility and to identify small companies that are growing, profitable and undervalued… 

  • Revenue growth and growth in earnings per share (EPS) of more than 10% in three of the past five years. I also want to see clear drivers of future growth for a company such as a promising new product or exposure to a new market niche.
  • Above-average profit margins versus those of the company’s peers and industry group.
  • Low debt.
  • Insider ownership greater than 15%. When members of the management team invest a large amount of their own personal wealth in a company, it’s a strong sign that their interests are aligned with those of the shareholders.
  • P/E lower than the company’s historical average P/E. I also check that the company’s estimated future P/E is in line with expected future growth. Below-average P/Es often indicate a company is selling for less than it is worth, although you’ll still need to evaluate any challenges or problems the company is facing.

Best Small-Cap Stocks Now

The following six small companies meet all the criteria above and offer the potential for market-beating returns…

1. Allient (ALNT). Some of the most attractive small-caps operate in obscurity in the industrial sector. Despite its tiny market capitalization of $350 million, Allient’s specialty motors and motion and power control components are critical across dozens of industries. They are found in everything from kidney dialysis machines to F-35 fighter jets and Chinook military transport helicopters to high-performance racing motorcycles and factory-floor robots. The company, which has more than $300 million worth of back orders, is tapping into two massive industrial growth trends…

  • Energy efficiency. About 40% of all global electricity consumption is derived from motors, so even minor improvements in the efficiency of a motor, the drive and the gearing system can make a major difference in energy consumption.
  • Increased automation in US factories, which is necessary to counter high labor costs and worker shortages.

Recent share price: $18.56.*

2. InMode (INMD) specializes in making high-tech equipment and workstations for surgeons and other clinical practitioners of medical aesthetics and body contouring. The company’s radio-frequency procedures can tone muscles, eliminate fat deposits and remove unwanted hair. With net profit margins of close to 40%, InMode is a profit-making machine. That said, the medical-device maker’s most recent quarterly earnings slumped significantly year over year. Reason: InMode’s pricey treatments aren’t covered by insurance, and many patients have put off elective procedures to save money in case the economy falls into a recession. Even if the economy stumbles, I’m confident the growth for InMode’s non-invasive, in-office procedures will rebound strongly. The results are comparable to plastic surgery and laser treatments but without the shortcomings of anesthesia, downtime and scarring. Also, the rise in popularity of weight-loss products such as Ozempic has created a rising market for InMode patients who want to get rid of excess skin.

Recent share price: $17.09.

3. International Money Express (IMXI). Commonly known as Intermex, this rapidly growing digital- payment and money-transfer service processed about 15 million transactions last year between the US and more than a dozen Latin America countries. Headquartered in Miami, Intermex has benefited from the huge influx of immigrants in recent years who rely on non-traditional banking to pay bills, cash checks and send funds to family members internationally. Intermex also has an advantage over competitors such as Square and PayPal because the company has spent years building its retail, brick-and-mortar network, which is difficult to replicate. Last year, the company also teamed up with Visa to allow customers to transfer money using the Intermex app to and from 20 countries in Asia, Africa and Europe.

Recent share price: $17.83.

4. Monarch Casino & Resorts (MCRI) is often overlooked by investors because it operates outside the massive gambling nucleus of Las Vegas and owns just two properties—the Atlantis Casino Resort Spa in Reno, Nevada…and the Monarch Casino Resort Spa Black Hawk, outside of Denver. Even so, this superbly managed, family-run business is a regional gem. It has no debt, recently completed $400 million worth of expansions and upgrades, and has the highest average pretax profit margins of any major or regional casino business in the country. In the future, shifts in demographics and new state legislation should boost Monarch’s earnings growth. Nevada is seeing substantial population growth, and the Atlantis casino has become a destination point for gamblers in Northern California, Oregon and Washington. Plus, the Black Hawk location is drawing many more high rollers thanks to the Colorado legislature’s decision to allow unlimited wagering limits on table games.

Recent share price: $74.32.

5. Shutterstock (SSTK) dominates the market for stock Internet content for websites and digital advertising materials. It has a library of more than 450 million images and millions of videos, as well as music tracks, sound effects and three-dimensional clips. The company’s subscriber base has recently doubled to more than a million thanks to recent acquisitions such as GIPHY, the world’s largest library and search engine for GIFs, short soundless repeating animations. Investors have been leery of Shutterstock over concerns that artificial intelligence (AI) apps that create online content will lessen the demand for stock photographs and video clips. But Shutterstock actually is benefiting from the trend, forging savvy deals and partnerships with ChatGPT parent, OpenAI, and licensing out its expansive image library to train AI models.

Recent share price: $33.59.

6. Trex (TREX) manufactures ecofriendly composite boards for residential decks. The decking, made of sawdust and recycled plastics, lasts twice as long as pressure-treated lumber and requires less maintenance. Trex controls nearly half the non-wood decking market in the US and is prominently stocked at both Lowe’s and Home Depot. This year, higher mortgage rates have slowed Trek’s earnings and hurt the stock because buyers are not purchasing homes and putting in decks, and homeowners are not remodeling. The company is using this lull to retool its plants, broaden its offerings of unique colors and finishes, and expand into new markets such as railing systems for commercial buildings and sports stadiums.

Recent share price: $64.07.

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