Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / Small Caps Are Quietly Crushing the S&P 500 This Quarter
Transcript
- Lucas: Luna, I want to start with a number that's been bugging me all week. The Russell 2000 is up three point six percent in the last five trading days. Luna: That's almost triple the S&P 500's gain over the same stretch. And it's not just a five-day blip. Lucas: Right. The Russell is up about eight percent quarter to date. The S&P is basically flat. For anyone who's been ignoring small caps since the 2022 bear market, this is the kind of divergence that demands a closer look. Luna: So what changed? Is this purely a rate-cut rally or is there something more structural happening? Lucas: It's partly rates, but I think the real story is earnings. Small-cap companies have been reporting better than expected results this quarter. According to FactSet, the percentage of Russell 2000 companies beating on earnings is around sixty-five percent, which is actually higher than the S&P 500's beat rate. Luna: That's striking because small caps usually have more variability in earnings — more misses, more volatility. But if the beat rate is actually higher than large caps, that changes the narrative. Lucas: Exactly. And the bar was low. Analysts had cut estimates aggressively heading into this earnings season, so the beats are partly about low expectations. But the guidance has been decent too. Companies are talking about stable input costs, easing labor pressure, and selective demand improvements. Luna: What about the regional banks? They're a big chunk of the Russell. We've seen BAC and JPMorgan basically flat this week, but some smaller banks have been ripping. Lucas: Yeah, regional banks have been a tailwind for the index. The KBW Regional Banking Index is up about six percent this month. The logic is that if the Fed eventually cuts rates, regional banks' net interest margins stop compressing and their loan books become more valuable. Plus, the deposit flight fears from early 2023 have mostly faded. Luna: So you're seeing a rotation out of mega-cap tech into these neglected areas. NVIDIA is down almost five percent in the last five days. Apple is up, but Microsoft and Alphabet are flat to down. Lucas: It's a classic broadening trade. The S&P 500 has been dominated by the Magnificent Seven for so long that when those stocks stall, money has to go somewhere. And small caps are one of the few places that still look cheap on a price to earnings basis. The Russell is trading at roughly fifteen times forward earnings, while the S&P is at twenty-one. Luna: That's a thirty percent discount. But value traps are real in small caps. How do you separate the companies that are genuinely turning around from the ones that are just riding the macro wave? Lucas: I think you have to look at three things: balance sheet strength, free cash flow generation, and insider buying. One name that ticks all three boxes is a company called Simpson Manufacturing, ticker s s d. They make wood connectors and structural products for construction. Not glamorous, but they have zero net debt, a trailing free cash flow yield of about six percent, and insiders have been buying shares this quarter. Luna: That's a very specific pick. I like that it's tied to housing and construction — which is a sector that could benefit if rates come down. But what if rates stay higher for longer? Lucas: Then Simpson still holds up because its customers are mostly repair and remodel, not new construction. That end market is more stable. And the company has pricing power — they raised prices twice last year and volumes barely budged. That's a sign of a moat. Luna: That's a good example of the kind of stock that gets overlooked when everyone's focused on AI and mega-caps. The Russell is full of these quiet compounders. Lucas: And that's the broader point. The small-cap rally this quarter isn't just a reflex rally. There's genuine earnings improvement, attractive valuations, and a macro backdrop that's starting to favor them. If you're a stock picker, this is the most interesting part of the market right now. Luna: I want to go back to something you said about insider buying. Are you seeing a broad uptick in insider purchases across the Russell? Lucas: Yes, actually. According to data from InsiderScore, insider buy-sell ratios for small caps hit a three-year high in April. Executives are putting their own money to work. That's a contrarian signal that often precedes outperformance. Luna: That's compelling. So if someone wanted to act on this, would you recommend a broad ETF like IWD or VTV, or should they be picking individual names? Lucas: I think a blend makes sense. IWD and VTV are good core holdings — they give you exposure to the value factor. But the real alpha in small caps comes from individual names where you have a thesis. Simpson is one. Another is a company called Kinsale Capital, ticker K-N-S-L. They're a specialty insurer focused on small to medium businesses. They've grown earnings per share at a compound annual growth rate of over twenty percent for the last five years, and they still trade at a reasonable price to earnings ratio given that growth. Luna: Specialty insurance is a space that tends to be less cyclical. So even if the economy slows, their pricing power holds up. That's a smart pick. Lucas: Exactly. And Kinsale has a return on equity of over eighteen percent, which is best-in-class. The market is starting to notice — the stock is up about twelve percent this quarter. But I think there's still room to run. Luna: So the takeaway is: small caps are having a moment, but you have to be selective. The broad rally is real, but the real money will be made in names with strong fundamentals. Lucas: Yeah. And this is a conversation that applies beyond just stock picking. If our money conversations have helped you think about a decision differently, consider supporting the show at buy me a coffee dot com slash fexingo. Listener support is what keeps us ad-free and focused on the research. Luna: Absolutely. It's a small way to help us keep doing what we do. And we really appreciate it. Lucas: Okay, back to the market. One more thing I want to flag: the dividend growth angle inside small caps. A lot of these companies are starting to increase dividends because their cash flows are improving. Luna: That's a shift. Small caps traditionally reinvest everything into growth. But if they're returning capital to shareholders, it signals confidence in the business. Lucas: Right. And that's another reason the rotation might have legs. When companies start paying dividends, it attracts a different class of investor — the income-oriented funds that have been hiding in bonds. That could provide a steady bid under these stocks. Luna: So to sum up: small caps are outperforming on earnings beats, insider buying, and a broadening trade away from mega-cap tech. The key is to look for balance sheet strength, free cash flow, and dividend potential. Lucas: That's the playbook. And if you want to dig deeper, pull up the Russell 2000's price to earnings ratio versus the S&P 500. The gap is as wide as it's been since the dot-com bust. That's the kind of statistic that makes a value investor's eyes light up.