One of our 10 Principles of Value Investing™ is “catalyst for recognition.” That’s because it’s not enough to identify promising companies with strong fundamentals. We want to own stocks whose attractive attributes could soon be recognized by the market and reflected in rising shares prices.
A catalyst, however, can come in many forms. In some instances, it’s a strategy or quality specific to one company. In other cases, it may be a broader market development, such as an emerging consumer or technological trend, like the AI boom that’s been a dominant theme driving large tech stock outperformance in recent years. Sometimes, though, it’s not so straight forward. For instance, investors this year have been so fixated on AI that they seem to be missing out on other opportunities in the marketplace. This has led to a valuation disconnect of historic proportions between small and large cap stocks, in which investors have been ignoring the small universe to the point that this oversight itself could be a catalyst for eventual recognition.
Recently, we’ve seen this dynamic play out with the NFIB Small Business Optimism Index, which gauges attitudes of small businesses by measuring variables such as their plans to increase employment and capital expenditures as well as their expectations for future revenues. This Index has been rebounding strongly in recent months, hitting a reading of 100.3 in July, up from 97 in June, and above the 52-year historic average of 98. As you can see below, improvements in optimism tracked by the National Federation of Independent Business have historically coincided with small cap value outperformance over large stocks, as measured by the Russell 2000® Value Index versus the S&P 500 Index. Emerging from recessions in 2009 and 2020, for instance, rising NFIB optimism was echoed by strong rallies in small value stocks.
Source: FactSet Research Systems Inc. Monthly data from 8/31/2005 to 8/29/2025. The data in this chart represents a year-over-year percentage change in the NFIB Small Business Index compared to the Total Return of the Russell 2000® Value Index relative to the S&P 500 Index. Russell 2000® Value Index measures the performance of those Russell 2000® companies with lower price/book ratios and lower forecasted growth characteristics. NFIB Small Business Optimism Index is a small business optimism index compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members. The index is a composite of ten seasonally adjusted components based on questions on the following: plans to increase employment, plans to make capital outlays, plans to increase inventories, expect economy to improve, expect real sales higher, current inventory, current job opening, expected credit conditions, now a good time to expand, and earnings trend. S&P 500 Index is an index of 500 U.S. stocks chosen for market size, liquidity and industry group representation and is a widely used U.S. equity benchmark. All indices are unmanaged. It is not possible to invest directly in an index. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.
This year, however, that’s not been the case, as small cap value businesses have continued to underperform even as the NFIB Small Business Optimism Index has rebounded sharply. We understand there are no guarantees the market will recognize this disconnect and begin to embrace small value stocks in swift order. But the longer these historic gaps continue to expand, the more the disconnect itself could become a catalyst for recognition.
Catalysts for recognition alone, of course, are not enough. Even if the market detects this disconnect, it’s our responsibility to identify the companies that are most likely to benefit from such a potential rebound. That’s where the other nine factors in our 10 Principles of Value Investing™ come into focus, requiring us to look for fundamentally attractive attributes such as low valuations, strong balance sheets, capable management teams, and compelling business strategies that help companies stand out.