As many of my followers know, I am quite interested in the small-cap space of markets because of what I believe to be incredible market inefficiencies. Even Buffett himself has said:

“The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts back then. It’s a huge structural advantage not to have a lot of money.” – Warren Buffett

The point is, if you are managing too much money, deploying a portion into a small-cap will either move the market too much, lack the liquidity needed (imagine trying to build a position without tipping your hand), or the revenues simply aren’t large enough yet. Buffett has also noted:

“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. It’s a huge structural advantage when you’re working with small sums of money.” – Warren Buffett

Smaller investors have an edge. You can dive deep, do the research, and find the small caps positioned to grow. But—and it’s a big but—most small companies don’t make it to the big leagues and it’s widely known that the only a small, select few, graduate to the large cap arena. So, knowing your odds is critical, but that also leads me to the Russell 2000, the index many use as a barometer for small caps or as a way to get exposure, which is inherently stupid as it takes away the art and science of finding the hidden gems poised to grow.

My problem with the Russell 2000 is that it’s fundamentally flawed. It’s designed to hold onto under performers and kick out the winners. Yes, you heard that right. Every time a company succeeds and grows too large, it gets booted from the index. What remains? A hodgepodge of companies that haven’t grown or are slowly declining. It’s as if the index is saying, “Let’s keep the leftovers and pass the filet mignon to someone else.”

The index is designed to kick out companies that grow too large. However, that’s the whole point of small cap picking so why buy an ETF that ditches them when they get too big. Consider this: before the S&P 500 had Apple, it was in the Russell 2000. Same with NVIDIA. And Amazon, and many more. In each instance, just as these companies were hitting their growth, the Russell kicked them out for being too large.

While I have some issues with the Russell 2000 Index and ETF, I still believe the future is bright for us Small-cap investors. The key is being smarter than the index, holding on to your winners, and better yet, building your own holdings for the long term and rebalancing as needed. Instead of blindly following the Russell 2000 for all of the reasons above, I’ve instead started my curated list of 1,000 small-cap stocks following a new era of methodology that keeps the biggest winners for a specific period until they breach specific thresholds. This allows for small cap investing to gain in a major way.

Sadly, the Russell’s rules are severely flawed and has missed out on epic winners that they were the first to find.

If you found this post interesting, I’ve laid out the basic frameworks for my new Index Stef’s Super Spicy 1000:

Admission Criteria:

• Market Cap Below $10 Billion: To join the index, a company’s market capitalization must be under $10 billion but no smaller than $25 million.
• Exchange Validity: To join the index, a company’ must be well listed on a major exchange with clear upholding and proper filings by and with the exchanges, SEC, and other bodies. Without this, a company can’t be listed.

Exit Criteria:

• Market Cap Above $10 Billion: Companies can only be exited once they cross this threshold, however, unlike the Russell 2000, these companies can and will REMAIN in the index depending on specific milestones and benchmarks. Growth is celebrated, but it’s not the sole reason for removal. Exiting is based on a deeper evaluation through these if/then scenarios:
  • Management Shift: If the management team is fundamentally different from when the company was admitted.
  • Declining Revenues: If revenues are consistently falling, the hustle is likely gone.
  • Prolonged Losses: Companies with a negative net income for more than four consecutive quarters will be reconsidered.
  • Cash Flow Problems: If free cash flow is negative for four out of twelve quarters, alarm bells go off.
  • Outrageous Executive Compensation: If executive compensation—whether equity or cash—is 10x larger than the average employee salary, and the executive is not the original founder, we’ll show them the door.

Balancing the Index:

• Diversification Matters: No single company will make up more than 5% of the index. This ensures balanced exposure across our spicy picks.

Philosophy Behind the Index:

Retain the Winners:

If a company is thriving, we keep it, even if it outgrows the small-cap label. Success shouldn’t be punished; it should be celebrated and leveraged for long-term growth.

Original Operators:

Founders and original teams often bring a unique passion and vision. Businesses still driven by these individuals are prioritized, as their leadership often sustains the company’s competitive edge.

Stick to the Core:

We value focus and staying power. Companies that veer too far off course from what made them great are not a fit for Stef’s Super Spicy 1000. Hustle and grind are non-negotiable.

Why This Approach?

While I have my issues with the Russell 2000 Index and ETF, I still believe the future is bright for small-cap investors. The key is being smarter than the index—holding on to winners, building a portfolio for the long term, and rebalancing as needed. Instead of blindly following flawed methodologies, I’ve crafted this curated list with rules that ensure we keep the best and brightest, but only for as long as they stay true to the grind.

More updates to come in what should be an exciting 2025! Please reach out to me if you want to discuss this in more detail. I am always looking to partner and build new things.