Small-cap stocks are having a good year. iShares Core S&P Small-Cap ETF (IJR), which tracks the S&P SmallCap 600 index, is up 23.6% year to date as of late August. This compares to a year-to-date return of 13.4% for iShares Core S&P 500 ETF (IVV).

There are two primary reasons for this.

First, earnings growth has been strong for small-cap companies. The blended second-quarter 2026 earnings growth estimate from LSEG I/B/E/S, which combines reported and estimated numbers, was 84.0% for Russell 2000 index companies as of July 30. Full-year 2026 earnings are projected to grow 87.8%.

Second, there has been an ongoing rotation this year out of the largest technology stocks and into other areas of the market. The lower valuations for small-cap stocks make them attractive for investors seeking to diversify.

Whatever the near-term drivers, it’s worth noting that over the long term, portfolios of small-cap stocks have outperformed portfolios of large-cap stocks. This is particularly the case for small-cap value stocks.

Stock selection matters since small-cap companies are riskier as a group. Their businesses tend to be more concentrated than those of large-cap companies, both in terms of product lines and geographic regions served. Small-cap companies also lack the same level of access to bond markets that large-cap companies enjoy, making it more difficult to raise capital. Investors who use disciplined strategies are rewarded for taking on these risks.

Two articles in this month’s issue offer suggestions for finding and analyzing small-cap stocks. One is more qualitative, while the other is quantitative.

Longtime AAII Journal contributor John Deysher explains the approach used by his fund, Pinnacle Value fund (PVFIX). Deysher and his team look for undervalued stocks—particularly those that appear to have temporarily fallen out of favor—with strong fundamentals, a sound business strategy and the potential for a catalyst to drive their stock price up. 

The O’Shaughnessy Tiny Titans screen is the most followed stock screen on AAII.com. Its current and long-term performance are big reasons why. The Tiny Titans screen identifies small companies with low price-to-sales (P/S) ratios (below 1.00) whose stocks have among the highest 12-month returns of all exchange-listed stocks. In this issue, AAII’s Michael Rose discusses the screen and shows you the stocks passing it.

Wishing you prosperity and good health,