After the September 2025 of the SmallCap Informer was published, news was released that long-term holding Air Lease (AL) was being acquired. This was particularly timely in light of my commentary from the September issue in which I outlined how our investing approach shares much with the methods used by acquirers of businesses. The philosophy of thinking like a buyer of businesses emphasizes a deep understanding of a company’s underlying business, its fundamentals, and its long-term prospects, rather than reacting to short-term market fluctuations or speculative trends.

The SmallCap Informer explicitly embraces this approach. Our “Quality and Growth At a Reasonable Price” (Q-GARP) methodology first and foremost seeks out well-managed businesses with strong fundamentals, and then seeks to buy them at attractive valuations.

For small company investors, this business-owner mentality is not just beneficial. It is often essential for identifying and capitalizing on opportunities that may be overlooked in larger, more liquid markets.

Small-cap companies frequently languish in the shadows due to a lack of institutional interest and limited analyst coverage. While large-cap stocks bask in the glow of wide analyst coverage, small-caps are often underfollowed by Wall Street, with consensus estimates for sales and EPS growth sometimes based on analysis from as few as one to five analysts (if any cover those stocks at all).

This obscurity leads to inefficiencies in pricing, which in turn creates golden opportunities for shrewd investors who are willing to conduct their own due diligence and focus on the company’s intrinsic value rather than market sentiment.

Small and medium-sized companies inherently experience a bumpier ride due to higher volatility, influenced by fewer analysts and low trading volumes. However, for a business-owner investor, this volatility is not something to be feared but rather a source of opportunity. Short-term market swings can provide ideal entry points to buy on the dip for such high-quality companies, empowering greater long-term success.

We acknowledge that stocks covered in the SmallCap Informer often have higher betas than the market, indicating greater sensitivity to market movements, but this increased risk is associated with the potential for higher returns.

Small-cap stocks frequently trade at remarkable discounts compared to their large-cap counterparts, sometimes hitting multi-decade lows. Historically, small companies often commanded a premium, making the current large-cap/small-cap valuation gap a potential treasure trove for discerning investors. This undervaluation creates a significant opportunity for investors focused on long-term value, as the market will always ultimately recognize any bargain, once the haze of market’s euphoria clears.

Many (though certainly not all) small companies are in early stages of their corporate life cycles, offering substantial growth potential that can lead to significant capital appreciation over time. As their operations expand, they can achieve economies of scale, reduce costs, and spread out selling, general, and administrative (SG&A) expenses over a wider base, leading to measurable expansion of profit margins over many years. This enables earnings per share growth to outpace revenue growth, a key driver of long-term stock price appreciation. SCI typically seeks out annual growth potential of at least 8% in both sales and EPS.

Companies with strong fundamentals, healthy cash flow, and impressive margins are also attractive to larger market players and private equity firms, making them appealing acquisition candidates.

While current higher interest rates can stifle some deals, accelerating merger and acquisition activity could benefit small companies as rates recede. A business-owner approach, focusing on these fundamental strengths, positions investors to benefit from such eventual takeovers.

Many small-scale businesses generate the majority of their revenues domestically, often operating in emerging industries. This domestic focus positions them to seize opportunities amid improving economic trends and can shield them, to some extent, from many of the global trade uncertainties that plague their larger competitors.

Core Principles of the Q-GARP Business Owner Approach

SCI’s Q-GARP methodology, adapted from Peter Lynch’s Growth At a Reasonable Price (GARP) methodology, encapsulates the business-owner mindset through its emphasis on Quality, Growth, and Reasonable Prices.

Quality (The “Q” in Q-GARP)

In essence, being a buyer of businesses, especially when it comes to small company stocks, means focusing on robust fundamentals and ideally stellar management of  companies, rather than the fleeting popularity or market sentiment of their stocks.

We like companies with high profitability, low profit volatility, and minimal use of leverage. SCI’s approach prioritizes companies that are profitable, have strong balance sheets, significant free cash flow generation, and prudent use of debt.

Our quality assessment places a primary focus on understanding a company’s profit margins, as management teams that succeed with “better” pre-tax profit margins are doing a “better” job at managing all of the various expense inputs and all of the revenue generation aspects of the business than peers.

Companies that meet SCI’s quality standards tend to be very disciplined borrowers, often carrying low or modest debt.

Growth (The “G” in Q-GARP)

The long-term appreciation of a stock is fundamentally driven by its earnings growth, which in turn is driven by sales growth. The business-owner approach looks for companies with clear drivers of future growth. For smaller, expanding companies, margin expansion and strategic share buybacks can accelerate EPS growth faster than revenue growth.

Reasonable Price (The “ARP” in Q-GARP)

This component involves buying stocks at valuations that are reasonable when compared to historical levels and future growth expectations. A contrarian attitude is key, taking advantage of mismatches between the market’s assigned value of an asset compared to estimates of its long-term prospects. Buying stocks when they are historically undervalued allows for P/E ratio expansion as a third source of investment return alongside capital appreciation and dividends.

This flexible approach allows investors to adjust their focus between growth and value depending on market conditions, becoming more growth-oriented in bear-trending markets where fast-growing businesses might be sensibly priced, and more value-oriented in up-markets where valuations become stretched.

Portfolio Management through a Business Lens

Adopting a business-owner perspective also extends to broader portfolio management strategies. For instance, a well-diversified, long-term focused portfolio should include both small and large companies, as diversification by company size provides optimal risk/reward characteristics. This helps mitigate risks, especially given that small-caps and large-caps tend to perform well at different times in economic and market cycles.

Patience is paramount for all investors, but especially for those investing in smaller companies. Positive operating news for small and medium-sized stocks often takes more time to be reflected in their stock prices due to less analyst coverage and reduced investor awareness. As I frequently point out, “over time, fundamentals always win out.”

A business-owner mindset eschews attempts to time the market’s near-term direction. Instead, it advocates remaining fully invested in equities and using bear markets as opportunities to improve portfolio quality and expected return by deploying cash into attractively priced, well-run businesses. Reacting to the fearfulness of other investors or trying to capitalize on fads & trends is counterproductive to successful investing.

Even the most successful investors expect to make mistakes. The key is to analyze situations carefully, learn from errors, and avoid emotional decisions.

This long-term, disciplined approach, exemplified by SCI’s Q-GARP methodology, allows investors to uncover undervalued hidden gems in the less-scrutinized small-cap market, offering the potential for illuminating returns even amidst market volatility and economic uncertainty.

While large-caps may hog the spotlight, a healthy concentration in smaller stocks remains a key factor in achieving exemplary long-term returns.

In this issue of the SmallCap Informer, we introduce a manufacturer of medical supplies, another healthcare company that may help boost subscribers’ defensive portfolio positioning during these uncertain times.

Stay the course!

• DOUG GERLACH

Subscribers can read Doug's complete commentary and the in-depth profile of our recommended small company stock in the current issue of the SmallCap Informer stock newsletter. Not a subscriber? Subscribe to the SmallCap Informer and get monthly small company stock recommendations and updated buy/sell prices for each of the ~40 high-quality small company stocks currently covered in the newsletter.