INSIGHTS

On September 08, 2025

AAM Viewpoints — Setting the Stage for a Small Cap Comeback

It could be time for quality small cap growth stocks to finally begin outperforming large caps. Several key factors support the case including situation, concentration, valuation, deterioration, and duration. While the 2010s offered a zero-interest-rate policy and cheap capital that allowed suspect balance sheets to survive and even thrive, the 2020s have brought higher-for-longer rates that are more likely to reward strong balance sheets and efficient operations. The economic situation of the 2020s is not the economic situation of the 2010s.

The concentration of the Magnificent 7 at over 30% of the S&P 500 is reminiscent of concentrations that have historically foreshadowed shifts to smaller companies. If considering only the top five weights in the S&P 500 (below), this cohort of mega cap stocks has represented a greater portion of the index in any period since the early 1970s. 

Source: Sawgrass Asset Management | Past performance does not guarantee future results.

At the same time, small cap valuations have compressed to historic lows when compared to large caps, which have become generally overvalued. Rolling 10-year small cap returns relative to large caps are at lows seen only three times, almost four, since the Great Depression, i.e., -5%, with the latest instance in June 2025. Each instance marked a major opportunity for small cap investing (illustrated below). 

Source: Sawgrass Asset Management | Past performance does not guarantee future results.

Large caps have led small caps for over 14 years, exceeding the typical 11.5-year leadership cycle. The weight of the evidence indicates to us that quality small caps are primed for a rebound versus large caps. But another asset class — Private Equity (PE) — must be reckoned with when considering a small cap resurgence.

Private Equity Vs. Small Caps

Private equity’s growth poses a challenge for public small cap stocks. Over the past 25 years, the landscape of corporate financing and ownership in the United States has undergone significant transformation. This shift toward private markets has reshaped the small cap landscape, as private equity firms increasingly acquire promising companies before they reach public exchanges. By taking these firms private or delaying their IPOs (initial public offerings), private equity tends to capture high-growth phases, leaving fewer dynamic small caps for public investors¹. For investors, this means public small caps — despite their reduced pool — offer a unique opportunity to access undervalued companies with strong fundamentals, without the long lockup periods associated with private equity².

The private equity ecosystem has expanded dramatically, with the number of PE-backed companies surging from approximately 2,000 in the year 2000 to over 11,500 by 2023, a more than 400% increase. Conversely, the number of publicly-listed U.S. companies on the NYSE and NASDAQ exchanges has declined by 35%, from roughly 7,000 to 4,500 over the same period².

Past performance does not guarantee future results.

Companies are staying private longer, capturing early growth before going public, which reduces the number of high-quality small caps in the public market and raises concerns about the small cap premium². Despite this, we believe public small cap stocks offer potential advantages over private equity, especially in today’s market.

Why Small Caps Stand Out

1. Low Prices, High Potential

Small cap stocks are trading at trough-level valuations. The Russell 2000 is 1% below its long-term median and at historic lows relative to large caps². For 15 years, small caps have faced valuation compression of about 70 basis points annually, while large caps have experienced valuation expansion by 400 basis points per annum². History shows that when small caps have been this undervalued — with 10-year relative returns trailing large caps by 5% a year, as seen in June 2025 — they have delivered strong returns in the following years².

In the eras when small cap 10-year annualized relative returns to large caps register -5% or less, multi-year annualized returns tend to be strong for small caps.

Past performance does not guarantee future results.

However, with higher interest rates and financing costs, large cap out performance may not continue. Small caps, with their low valuations, are better positioned for growth in a normalizing market.

2. Strong Companies, Ready to Grow

Small cap stocks include many high-quality companies with strong growth potential. While over 40% of the Russell 2000 consists of non-profitable firms, the best small caps — those with solid balance sheets and efficient operations — are outpacing large caps in earnings growth². These companies are agile and well-positioned for growth.

3. Diversification Without the Hassle

Both small caps and private equity diversify portfolios, but in different ways. Private equity offers exposure to non-public companies, which can reduce volatility due to less frequent valuations². Small caps provide diversification within public markets, moving differently from large caps and benefiting from low valuations. Public market transparency, with strict reporting requirements, also builds investor confidence².

The Bottom Line

For investors seeking growth, we believe that flexibility, and value, public high-quality small cap stocks could be a strong choice. Historically, they tend to offer low valuations, solid growth potential, liquidity, disclosure and readiness to rebound.

Today’s market dynamics amplify this opportunity: small cap valuations are at historic lows compared to overvalued large caps. The concentration of the Magnificent 7 stocks echoes past market shifts that favored smaller companies. With small cap returns trailing large caps by 5% annually over the past decade, history suggests a major rebound could be near. By balancing small caps’ affordability and growth potential with private equity’s unique diversification, investors have the potential to build a portfolio that’s set for success in today’s market.

References:

1. Bain & Co., “Global Private Equity Report 2024”, January 2025
2. Marquette Associates, “What Has Private-Equity Done to Small Cap Stocks” May 2025
3. Furey Research Partners, “The Alternative to Private Equity is (Active) Public Small Caps” August 12, 2025

Additional Chart Sourcing:

• Furey Research Partners, “1Q25 Quarter-End Letter” 3/31/2025
• Citizens Bank, “The Public to Private Pivot Continues” December 2024

CRN: 2025-0902-12816 R

Opinions in this piece are those of Sawgrass Asset Management and are not necessarily that of AAM.

Any forecasts or opinions expressed herein are Sawgrass Asset Management’s own as of August 27, 2025 and are subject to change without notice. This information may contain, include or is based upon forward-looking statements. Past performance is not indicative of future results.