Investors have long been enamored with small-cap stocks and the potential for outsized profits.
Count me among them.
I have owned a lot of small caps through the years, and they are some of my biggest moneymakers. I like nothing better than investing in a small- or mid-cap stock and watching it grow into a large cap.
The math is simply in your favor. It’s easier for a $10 billion company to grow to $20 billion than it is for a $4 trillion company to grow to $8 trillion. Looking at you, Nvidia (NVDA).
Much of the market’s gains these last few years have come from tech giants like the “Magnificent Seven” stocks that average $2.6 trillion in valuation.
That bucks the long-established historical pattern of smaller stocks cranking out the biggest profits. And I think history is about to reassert itself with better times and bigger gains ahead for small caps.
One reason is the new One Big Beautiful Bill Act signed into law on July 4. (Yes, that’s the official name.) There’s a lot in there, but one somewhat overlooked section opens the door for businesses to deduct more of their interest payments on debt.
This is especially important for smaller companies, which typically finance their growth. A bigger chunk of their sales go to debt payments than they do at larger companies. That means bigger and more impactful savings – savings that go right to the bottom line.
That means accelerated earnings growth, one of the most important drivers of higher stock prices.
The same rationale applies to lower interest rates – which are coming. Lower interest rates translate into lower debt payments. Tariff rhetoric forced the Federal Reserve to pause intended rate cuts, but the central bank still forecasts two here in the second half of this year.
I think there’s a good chance we could see three as tariff deals are negotiated, the dust settles, and inflation remains low. Goldman Sachs also just increased its forecast to three cuts.
Either way, smaller companies have two important catalysts on the horizon to send share prices higher and accelerate Big Money inflows.
Actually, I already see strong inflows. Since the low on April 8, 83.3% of inflow signals in my Quantum Edge system are in stocks valued under $50 billion. (Thirty-eight percent in stocks valued $500 million to $5 billion and 45.3% in stocks worth $5 billion to $50 billion – which gets you more into mid- and smaller-large-cap range.)
Source: MoneyFlows.com
Some of that is because there are just a greater number of small caps than large caps, but that’s still a decisive data point.
More stocks also make it harder to pick the best ones, which is even more important with smaller stocks. They may have more upside potential, but they are also riskier.
Let me help get you started by relying on data.
I fired up the Quantum Edge system to analyze the top-rated stocks in the iShares Russell 2000 small-cap index. Here’s what I found…
#1: Credo Technology Group (CRDO)
Credo Technology Group makes semiconductors, hardware, and software for high-speed connectivity solutions in AI applications, cloud computing, and hyperscale networks.
It’s currently valued at $16 billion, which is more than some traditional definitions of small caps, but it’s in the Russell 2000 and is a nice size for growth – not too small and not too large.
Source: TradeSmith Finance
That 82.8 Quantum Score puts CRDO in my optimum buy zone and ties it for the top quant ranking in the Russell. I especially like that the Quantum Score is supported by equally outstanding fundamental and technical ratings.
High demand for Credo’s solutions drives robust growth. Earnings are estimated to surge 117% in the current fiscal year on 85% sales growth. Credo keeps 12 cents of every dollar it makes for a solid profit margin, and debt is low at 2.4% of equity. It may not benefit as much as smaller companies with more debt, but every little bit will boost earnings. And low debt speaks to the management and financial health of the company.
Shares have tripled since their early April lows, zooming from $30 to $90. Its technical metrics are nearly flawless, with the only caution being a somewhat high valuation after the massive rally. Shares trade at 61 times future earnings, which to me is not prohibitive but something to be aware of in your analysis.
CRDO also has significant Big Money interest, especially for a smaller stock. On the right side of the chart below you see seven green bars – Big Money inflow signals – since the end of May. There were six outflow signals (red bars) during the tariff turmoil – but look at all those inflows in the second half of 2024 as well.
Source: MoneyFlows.com
There’s a lot to like about CRDO. Unlike many smaller companies, it’s growing, profitable, and has institutional support.
#2: Rev Group (REVG)
Rev Group is also technically #1 because it shares that top 82.8 Quantum Score with CRDO. I put it at #2, though, because its fundamentals are a little weaker – though still excellent – and its technicals are overheated.
Source: TradeSmith Finance
The Quantum Score may be identical to CRDO, but this is a completely different business. Rev Group makes specialty vehicles like fire trucks, street sweepers, and RVs. Its three business segments are Fire & Emergency, Commercial, and Recreation.
That 91.2 Technical Score signals some froth and often precedes a pullback. Shares have run from $28 to $50 since the April lows, including a massive 15.4% one-day leap on June 4 after earnings. The company beat expectations and raised fiscal 2025 sales guidance.
I see seven inflow signals since May 9:
Source: MoneyFlows.com
Investors seem to like REVG’s strategic pivot to get out of bus building and focus on higher-margin products like specialty vehicles and RVs. And while the Fundamental Score is good, it’s worth watching revenue. Sales fell 9.8% last year, though the company still managed to grow earnings 17%.
#3: Acadia Pharmaceuticals (ACAD)
There are eight stocks in the Russell 2000 with the next highest and still outstanding Quantum Score of 81. That tells me right away that all eight have a higher probability of making money, but digging deeper into the data can help us focus on the best.
I put Acadia Pharmaceuticals in the #3 spot because of its beefy fundamentals.
Source: TradeSmith Finance
Acadia is a biopharmaceutical company. Its two primary areas of treatment are neuroscience – conditions such as Parkinson’s, psychosis, and Alzheimer’s – and rare neurological disorders.
The company has two approved therapies on the market: Nuplazid for hallucinations associated with Parkinson’s, and Daybue for Rett syndrome. It has other potential drugs in various phases of development, including one in Phase 3 trials for Alzheimer’s psychosis.
Sales grew 32% last year while earnings popped 64%, contributing to that strong fundamental rating. I also like the company’s 23.6% profit margin, and the 7.1% debt-to-equity ratio is exceptional for a smaller biotech company. (Lower rates and tax breaks will still help.)
May was a big month for shares after a solid earnings report and a favorable court ruling on patents. Shares soared from under $15 to $22 in just 10 days, generating the first Big Money inflows signal since February. That was followed by two more in June.
Source: MoneyFlows.com
The long-term data is undeniable: Stocks rise when interest rates fall, and smaller stocks outperform by a wide margin. With small caps trading at cheaper valuations than large caps, now is a good time to check your exposure to this exciting group of stocks.
Just be sure to stick to the data to tip the moneymaking odds in your favor. Many smaller companies are not yet ready for prime time, but those that are can generate sizable profits.
Real companies making real money with real institutional support are the way to make real profits.
Talk soon,
Jason Bodner
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Source: TradeSmith
