Small caps are beating the S&P 500, and Baron Capital sees more upside

Small caps are pulling ahead of large stocks in 2026, and Baron Capital says the turnaround has further to run, CNBC reported.

The Russell 2000 is up 13 percent in 2026, ahead of the S&P 500’s nearly 10 percent advance. That lead held through a bruising week for stocks after Democrats won control of both chambers of Congress and investors grew concerned that the election results could slow the artificial intelligence data center build-out. The small-cap index’s outperformance is a sign that the market is starting to broaden beyond the handful of mega-cap tech stocks that have driven the bulk of the returns in recent years.

Cliff Greenberg, portfolio manager of Baron Capital’s small-cap fund, told CNBC that the outlook is strong for small caps. Nearly a decade of underperformance versus larger companies has left them relatively cheap and overlooked by investors. The Russell 2000 has returned 159 percent to investors over the past 10 years, while the S&P 500’s total return in that time exceeds 300 percent. However, the Russell trades at 16 times trailing 12-month earnings, a sharp discount to the S&P 500’s multiple of roughly 25, according to FactSet data. That valuation gap is the case for the rotation: small caps are not better companies than large caps, but they are cheaper, and at some point cheap catches up.

Greenberg’s fund, the Baron Small Cap Fund (BSCFX), has gained 8 percent this quarter and is up about 3 percent in 2026. The fund’s weighting is skewed toward industrials, which account for 30 percent of holdings, followed by information technology at 22.4 percent. The industrial weighting reflects a bet on the physical economy: companies that make things, move things, and dispose of things. It is a contrast to the AI trade, which is weighted toward software and semiconductors.

Greenberg highlighted four stocks at Baron’s investment conference in New York City last week. Shake Shack is a new position, initiated in the second quarter. He sees room for the burger chain to open more restaurants, contributing to a long growth runway. Shake Shack opened 21 new company-operated locations in the third quarter and is targeting 1,500 locations long-term. Its forward price-to-earnings ratio of about 59 is far below its five-year average of 162, which means the stock is cheaper relative to its growth than it has been in years. Shares are up almost 15 percent over the past month.

Waste Connections is the third-largest solid waste company in North America, collecting and disposing of waste for about 9 million customers across 46 U.S. states and six Canadian provinces. Greenberg pointed to the company’s strong market share and attractive valuation. Its revenue mix is largely skewed to the U.S., which accounts for 86 percent of sales. Shares are up more than 8 percent in 2026. Waste is a boring business with predictable cash flows and pricing power, which is exactly the profile that works when interest rates are rising and investors want companies that can pass through costs.

Doncasters, under DPC Holdings, is an independent manufacturer of highly engineered engine products, including precision cast components. Its main end markets are aerospace and industrial gas turbines. Doncasters went public in June, and the stock initially popped after its IPO but is down 22 percent over the past month. Greenberg likes the company’s exposure to the industrial gas turbine market, which is greater than its larger competitors. The post-IPO decline is the kind of dislocation that small-cap investors look for: a good company whose stock has been beaten down for reasons unrelated to its business.

Texas Roadhouse, the casual dining chain known for steaks, ribs, and bread at affordable prices, has opened 830 restaurants across 49 states since it first opened in 1993. The company also owns Bubba’s 33 and Jaggers. Greenberg likes how management continues to open restaurants and expand its footprint. Texas Roadhouse opened five company-owned locations in the third quarter, including two Bubba’s and one Jaggers, and has over 15 openings scheduled for the fourth quarter. The company is on track to open about 35 restaurants across the three brands in 2026. Shares are up about 17 percent over the past year.

What I think

The valuation gap between the Russell 2000 and the S&P 500 is the strongest argument for the small-cap trade. Sixteen times earnings versus 25 times is a 36 percent discount, and that discount exists because investors have spent a decade crowding into the same handful of large-cap tech stocks. When the crowd starts looking elsewhere, small caps are the natural beneficiary. The question is whether the rotation is driven by genuine interest in small companies or by a sell-off in large caps that makes small caps look good by comparison, as some strategists have noted. The first is a healthy broadening; the second is a bear market in disguise.

Greenberg’s stock picks tell a story about what kind of small caps he likes. Shake Shack is a growth company at a discounted valuation. Waste Connections is a steady compounder with pricing power. Doncasters is a post-IPO dislocation. Texas Roadhouse is a unit-growth story. These are not speculative bets on unproven companies; they are established businesses with real revenue and real expansion plans. That is the right way to play small caps: buy companies that are profitable and growing, not companies that are promising to be profitable someday.

The inflation data is the risk. Greenberg said cooling inflation could boost smaller stocks, but the October CPI came in hot and the market is now pricing in a December rate hike. Small caps are more sensitive to interest rates than large caps because they have less cash, more debt, and less access to capital markets. If the Fed hikes by 50 basis points instead of 25, the cost of capital for small companies goes up and the valuation case weakens. The Russell 2000 at 16 times earnings looks cheap until earnings start falling because the economy slows.

The Baron fund’s 3 percent gain in 2026 is modest, and it trails the Russell 2000’s 13 percent. That gap reflects the difficulty of picking small caps that outperform the index. The index is weighted toward the stocks that have done well, and an active manager has to find names that will do well in the future. Greenberg’s four picks are reasonable, but the fund’s overall performance suggests that the small-cap turnaround is easier to identify than to capture. The rotation may be real, but profiting from it requires getting the stock selection right, and that is hard in any market cap range.