The Russell 2000, a benchmark index for small-cap stocks, has historically lagged behind the large-cap S&P 500. Over the past decade, the S&P 500 has delivered returns of 200.8%, nearly double the 103.2% return of the Russell 2000. Even in 2024, the S&P 500 outpaced small caps, returning 27.1% compared to the Russell 2000’s 16.1%. However, a shift may already be underway. Since the U.S. presidential election on November 5, the Russell 2000 has nearly matched the S&P 500’s returns, signaling a possible resurgence in small-cap performance. Analysts at CFRA forecast that the S&P SmallCap 600 Index will generate EPS growth of 20.9% in 2025 and 18.6% in 2026, a sharp contrast to the negative 8% EPS growth seen in 2024.
The economic and political landscape also seems to favor small caps. Historically, small-cap stocks have performed best when the economy emerges from a slowdown, credit spreads tighten, and investor risk appetite improves. Donald Trump’s return to the presidency has further buoyed optimism. Trump’s policies emphasize domestic economic growth, which directly benefits small-cap companies, as nearly 80% of Russell 2000 revenue comes from domestic operations. Additionally, the National Federation of Independent Business (NFIB) Small Business Optimism Index recently jumped above its 50-year average for the first time in three years following Trump’s election victory. This surge in optimism indicates renewed confidence among small business owners, a critical driver for small-cap growth.
Expert Explains Why Small and Mid-Cap Stocks Are Undervalued Gems
In an interview with CNBC on November 4, Charlotte Daughtrey, Equity Investment Specialist at Federated Hermes, discussed the current investment landscape, particularly focusing on the small and mid-cap market. She highlighted that these segments are currently trading at or below their long-term averages, offering a 25% discount compared to large caps. Typically, small and mid-cap stocks should command a 10% premium due to their higher growth potential, but the ongoing risk environment, exacerbated by the pandemic and the prolonged period of higher interest rates, has led to their devaluation and for active investors this presents a significant opportunity.
Daughtrey noted that the small and mid-cap space is particularly attractive due to its potential for mergers and acquisitions (M&A) activity. She explained that well-performing, niche-focused companies in this segment are often attractive targets for larger corporations seeking to acquire growth rather than investing heavily in research and development. This dynamic is particularly evident in the U.S., known for its innovative companies, and is a key reason why Federated Hermes is overweight in information technology. This sector not only offers growth but also benefits from the AI tailwind without being as crowded as some larger-cap technology stocks.
Daughtrey emphasized that small and mid-cap stocks are likely to perform well compared to large-cap companies if there is a strong economy in the United States because small and mid-cap companies are more domestically focused, with 70-80% of their revenues generated domestically compared to 50-50 for large caps.
The current economic and political landscape presents a compelling case for investing in small and mid-cap technology stocks.
A close-up of a person's hand signing a mortgage document.
Our Methodology
To compile our list of the 12 best technology penny stocks to buy according to hedge funds, we used Finviz and Yahoo stock screeners to find the 30 largest technology companies trading below the price of $5, as of December 23. Then we used Insider Monkey’s Hedge Fund database to rank 12 stocks according to the largest number of hedge fund holders, as of Q3 2024. The list is sorted in ascending order of hedge fund sentiment.
Why do we care about what hedge funds do? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
Blend Labs, Inc. (NYSE:BLND) is a financial technology company that offers a cloud-based platform designed to simplify and automate the mortgage lending and banking process. The platform helps financial institutions streamline workflows, reduce loan processing times, and improve customer experiences. Blend Labs, Inc. (NYSE:BLND) serves major banks, credit unions, and fintech firms, including clients such as Wells Fargo and U.S. Bank. The company primarily earns revenue from its software subscription model.
Despite the challenging macroeconomic environment, Blend Labs, Inc. (NYSE:BLND) is seeing renewed optimism and momentum in the mortgage industry. The company is investing in mortgage-related products to stay ahead of industry trends and meet the evolving needs of its customers. One key initiative is the development of the next-generation regenerative finance (ReFi) solution, known as Rapid Refi, which is designed to provide a seamless and frictionless refinancing experience. This solution is expected to drive higher conversion rates and retention for the company’s customers, ultimately leading to increased revenue and improved unit economics for the company. Additionally, Blend Labs, Inc. (NYSE:BLND) is actively expanding its customer base and pipeline, with recent wins with PenFed Credit Union to enhance its home lending operations. The company is also in negotiations with other top-tier financial institutions.
One of the most significant milestones for Blend Labs, Inc. (NYSE:BLND) in Q3 was achieving its first positive non-GAAP operating income quarter as a public company. To maintain and build upon this profitability, the company is transitioning to a simpler, software-focused model. This approach leverages the company’s core strength, which enables best-in-class experiences across a wide range of solutions. Blend Labs, Inc. (NYSE:BLND) is also streamlining operations and reducing costs to create operational leverage that will drive long-term profitability.
Overall, BLND ranks 10th on our list of best technology penny stocks to buy according to hedge funds. While we acknowledge the potential of BLND to grow, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than BLND but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
