14 Mar 2025
By Matt Mahon, Portfolio Manager, US Smaller Companies Equity Strategy
Key Insights
The stock market’s impressive gains in recent years have masked a less encouraging longer-term trend—the number of public companies in the United States has been cut by more than half over the past 25 years. The incredibly shrinking stock market poses a challenge for investors, and the type of passive approach often employed by investors to access the world of the S&P 500 may not work as well down the market capitalization scale. At the same time, uncertainties created by the change in administration, and related questions about next policy moves by the Federal Reserve, add further near-term risks for many—but not all—smaller companies.
While these risks are real, they do not diminish what is a positive longer-term structural environment for U.S. small-cap equities. Historically cheap relative valuations, established onshoring/reshoring trends, and a pro-domestic business administration, augur well for the outlook. We believe that the key to success for long-term investors is choosing how to allocate to this part of the market. Looking at both opportunities and risks, now is not the time for a passive approach.
The incredible shrinking equity market
The number of public companies in the FT Wilshire 5000 Total Market Index—widely regarded as the best single measure of the U.S. equity market—has fallen from a peak of 7,562 in July 1998 to just 3,326 as of December 2024. The last time the FT Wilshire 5000 actually had at least 5,000 listed stocks was the end of 2005.1
The number of publicly traded companies is declining
(Fig. 1) FT Wilshire 5000 Total Market Index number of listed companies—peak vs. today
As of December 2024.
Comparison of peak number of index-listed companies (July 1998) versus today (latest data update, December 2024).
Source: FT Wilshire Indexes (see Additional Disclosures). Analysis by T. Rowe Price.
The shrinking opportunity set can also be traced to several other trends: increased merger and acquisition activity and private equity deals; a significant decline in recent years in the number of companies going public due, in part, to increased regulation; the rise of shareholder activism; and various corporate failures.
As more public companies get acquired or sell out to private investors, there has been a dearth of new initial public offerings (IPOs) to replace them. IPO activity has fallen by more than half since peaking in the late ‘90s and, aside from a brief outlier period during 2021-2022, has seen a decline in recent years.
This decline in IPO activity has been partially fueled by a surge in venture capital investment that has enabled startup businesses to expand and gain access to capital while avoiding the scrutiny and transparency of the public market. By the time some firms are ready to go public, they may have already grown beyond the reach of small-cap investment managers.
The increased regulatory burden and compliance costs stemming from the Sarbanes-Oxley Act of 2002 has also greatly dampened the desire to go public. The average range of going public today costs USD 36 million2—rather daunting for a company with USD 250–500 million in revenue, for example. Companies are staying private longer than they have historically, and we have seen a drastic reduction in the number of annual IPOs since the introduction of the Sarbanes Oxley Act. During the two-decade period ending 2004, we saw an average of 297 company IPOs each year. For the 20-year period ending 2024, the average number had fallen to 118.3
At the same time, high stock multiples and the relatively low cost of capital has enabled larger companies to buy out smaller ones at hefty premiums in an effort to meet their growth targets.
U.S. Initial public offering activity is declining
(Fig. 2) Annual U.S. IPOs ex SPACs1
As of December 2024.
1 SPACs = Special purpose acquisition companies.
Deal value represents the total value raised in IPOs each year.
Sources: Financial data and analytics provider FactSet. Copyright 2025 FactSet. All Rights Reserved; Bloomberg Finance L.P., and Jefferies (see Additional Disclosures). Data analysis by T. Rowe Price.
Disproportionate impact on the smaller companies segment
The shrinking equity market has had a disproportionate impact on the Russell 2500 Index. While the index is rebalanced annually and remains at 2,500 names, the companies added to the index in recent years have tended to be smaller, more illiquid, and of lower quality than the firms they replaced. A study by Furey Research Partners shows that the median return on equity of the Russell 2500 Index has fallen from a peak of 12.6% in 1998 to 5.5% today.4 This decline is particularly pronounced among the smallest companies in the index.
"While the index is rebalanced annually and remains at 2,500 names, the companies added to the index in recent years have tended to be smaller, more illiquid, and of lower quality than the firms they replaced."
The erosion in the index’s quality is reflected in Figure 3, which shows that more than a third of the companies in the index do not generate any positive earnings. Companies with negative earnings are more likely to struggle to generate the cash needed to maintain solvency and may need to raise capital by increasing leverage or issuing additional stock to fund their operations.
More than a third of smaller companies are non-earners
(Fig. 3) Selectivity in the small-cap space is key
As of December 2024.
Comparison of profit vs loss-making companies in the Russell 2500 Index vs the S&P 500 Index, annually.
Source: Financial data and analytics provider FactSet. Copyright 2025 FactSet. All Rights Reserved. Data analysis by T. Rowe Price.
After decades of ultralow interest rates, investors have also recently refocused on the refinancing risk of smaller companies. However, it is worth noting that not all small companies share the same level of such risk. Roughly one in five smaller companies, for example, do not carry any debt on their balance sheet. And those that do vary widely in their ability to achieve more favorable outcomes when it comes time to renegotiate terms with lenders. Understanding and identifying the potential winners, while avoiding the losers, is precisely what a quality active manager aims to achieve for investors in this under‑researched area of the equity market.
When money floods into passive products such as exchange-traded funds and index funds, it helps drive up the shares of mediocre companies alongside stronger competitors. This is despite the risk posed for passive investors by the lower quality and reduced liquidity of the small-cap segment. In the event of a sustained market downturn, sellers may have trouble finding buyers for lower-quality, less liquid stocks amid a potential rush to exit.
Separating the wheat from the chaff
The decline in number and overall quality of the small-cap market also poses challenges for active investors. Their objective is to separate the wheat from the chaff and not overpay for it. It is crucial to stay laser-focused on understanding both the risks and potential rewards, with the aim of identifying the best opportunities over a three- to five-year horizon. Understanding and staying close to these companies in what is an under-researched area of the equity market will be even more important in the coming years.
A disciplined, fundamental approach is crucial in identifying reasonably priced, quality companies with positive earnings; above-average, persistent free cash flow; and capable management teams. We believe that an active, patient approach will prove rewarding over time, while focusing on higher-quality stocks helps provide downside support during periods of market volatility.
A positive and durable structural outlook
Investing in small-cap stocks has become more challenging, with a smaller opportunity set for public markets. Near-term market and economic risks add further uncertainty. However, many factors contribute to a positive longer-term structural setup for the sector. These include historically cheap relative valuations, established onshoring/reshoring trends, and a pro-domestic business environment. The next 12 months could be choppy, but for long-term investors, there are compelling reasons for active investing in this dynamic and innovative segment of the U.S. equity market.
Matt Mahon, Portfolio Manager, US Smaller Companies Equity
1 FT Wilshire Indexes, as of December 2024.
2 Source: PWC: “Cost of an IPO” Data. As of December 31, 2024.
3 Source: Initial Public Offerings: Updated Statistics Jay R. Ritter, Eugene F. Brigham Department of Finance, Insurance, and Real Estate, Warrington College of Business, University of Florida. As of December 31, 2024.
4 Source: Furey Research Partners. As of September 30, 2024.
Additional Disclosures
The Wilshire Indexes(SM) and Wilshire Atlas(SM) have been licensed for use by T. Rowe Price and all content is © 2025 Wilshire Associates Incorporated. All rights reserved.
Jefferies data was prepared by personnel who are associated with Jefferies (Jefferies International Limited, Jefferies Hong Kong Limited, Jefferies Singapore Limited, Jefferies (Japan) Limited, Tokyo Branch, Jefferies India Private Limited, Jefferies (Australia) Pty Ltd); or by personnel who are associated with both Jefferies LLC and Jefferies Research Services LLC (“JRS”). Jefferies LLC is a US registered broker-dealer and is affiliated with JRS, which is a US registered investment adviser. JRS does not create tailored or personalized research and all research provided by JRS is impersonal. If you are paying separately for this research, it is being provided to you by JRS. Otherwise, it is being provided by Jefferies LLC. Jefferies LLC, JRS, and their affiliates are collectively referred to below as “Jefferies”. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified, therefore, we do not guarantee its accuracy. Additional and supporting information is available upon request. This is not an offer or solicitation of an offer to buy or sell any security or investment. Any opinion or estimates constitute our best judgment as of this date and are subject to change without notice. Members of Jefferies and their respective directors, officers and employees may buy or sell securities mentioned herein as agent or principal for their own account. Upon request members of Jefferies may provide specialized research products or services to certain customers focusing on the prospects for individual covered stocks as compared to other covered stocks over varying time horizons or under differing market conditions. While the views expressed in these situations may not always be directionally consistent with the long-term views expressed in the analyst’s published research, the analyst has a reasonable basis and any inconsistencies can be reasonably explained. In Australia, this report may contain general advice. Where this report refers to a particular financial product, you should obtain a copy of the relevant product disclosure statement or offer document before making any decision in relation to the product. This report may contain forward looking statements that may be affected by inaccurate assumptions or by known or unknown risks, uncertainties and other important factors. As a result, the actual results, events, performance or achievements of the financial product may be materially different from those expressed or implied in such statements. Past performance is not indicative of future performance.
This report/model may contain information obtained from third parties, including ratings from credit ratings agencies such as Standard & Poor’s. Reproduction and distribution of third party content in any form is prohibited except with the prior written permission of the applicable third party. Third party content providers do not guarantee the accuracy, completeness, timeliness or availability of any information, including ratings, and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such content. Third party content providers do not provide any express or implied warranties, including, but not limited to, any warranties of merchantability or fitness for a particular purpose or use. Third party content providers are not liable for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including lost income or profits and opportunity costs) in connection with any use of their content, including ratings. Credit ratings are statements of opinions and are not statements of fact or recommendations to purchase, hold or sell securities. Such credit ratings do not address the suitability of securities or the suitability of securities for investment purposes, and should not be relied on as investment advice.
This report/model or any portion hereof may not be reprinted, sold or redistributed without the written consent of Jefferies or its affiliates. Neither Jefferies or its affiliates nor any officer nor employee of Jefferies or its affiliates accepts any liability whatsoever for any direct, indirect or consequential damages or losses of any kind arising from any use of this report/model or its contents.
For Important Disclosure information, please visit our website at javatar.bluematrix.com/sellside/Disclosures.action or call 1.888.JEFFERIES.
Important Information
This material is being furnished for general informational and/or marketing purposes only.
The views contained herein are as of February 2025 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Performance quoted represents past performance which is not a guarantee or a reliable indicator of future results. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.
Australia—Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 28, Governor Phillip Tower, 1 Farrer Place, Sydney NSW 2000, Australia. For Wholesale Clients only.
Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to non‑individual Accredited Investors and non-individual Permitted Clients as defined under National Instrument 45-106 and National Instrument 31-103, respectively. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.
EEA—Unless indicated otherwise this material is issued and approved by T. Rowe Price (Luxembourg) Management S.à r.l. 35 Boulevard du Prince Henri L-1724 Luxembourg which is authorised and regulated by the Luxembourg Commission de Surveillance du Secteur Financier. For Professional Clients only.
New Zealand—Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 28, Governor Phillip Tower, 1 Farrer Place, Sydney NSW 2000, Australia. No Interests are offered to the public. Accordingly, the Interests may not, directly or indirectly, be offered, sold or delivered in New Zealand, nor may any offering document or advertisement in relation to any offer of the Interests be distributed in New Zealand, other than in circumstances where there is no contravention of the Financial Markets Conduct Act 2013.
Switzerland—Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.
UK—This material is issued and approved by T. Rowe Price International Ltd, Warwick Court, 5 Paternoster Square, London EC4M 7DX which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.
USA—Issued in the USA by T. Rowe Price Investment Management, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.
© 2025 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.
