U.S. small-cap equities have defied traditional logic in 2025. The companies investors have typically prized for their prudence, those with steady earnings and consistent dividends, have lagged behind the more speculative corners of the market. Instead, firms with no profits and no payouts have been leading performance charts, marking a striking reversal of the patterns that dominated much of the post-global financial crisis era.

• Risk Appetite Revival: Speculative small caps are benefiting from renewed enthusiasm for growth optionality rather than cash flow discipline.
• Liquidity and Leverage Effects: Easy financial conditions and the return of retail flows have amplified momentum in unprofitable names.¹
• Valuation Divergence: Dividend payers and profitable small-cap firms now trade at unusually wide valuation discounts, potentially setting up a mean-reversion opportunity.

Figure 1 captures a rare market inversion: In 2025, unprofitable and non-dividend-paying small caps are sharply outperforming their higher-quality peers. After years when fundamentals drove returns, investor sentiment has pivoted toward speculative growth. The data underscores a risk-on rotation, liquidity-driven exuberance and a potential setup for future mean reversion.

Figure 1: Something New under the Sun?

Despite 2025's surge in "junk" small caps, longer-term results, shown in figure 2, reaffirm the value of fundamentals. Over the past six years, profitable and dividend-paying companies have delivered the strongest compounded gains, while unprofitable firms remain in negative territory. The data highlights that short-term speculation fades, but quality compounds over time.

Figure 2: Longer Horizons May Look Different from Shorter Periods in Small-Cap Performance

Conclusion: A Look at Two Exchange-Traded Funds Focused on U.S. Small Caps

The most widely referenced benchmark for U.S. small-cap equity performance is the Russell 2000 Index. The iShares Russell 2000 ETF (IWM) is designed to track the total return performance, before fees, of this benchmark. As of September 30, 2025, it had roughly 28% of its weight in companies that had negative earnings over the prior 12 months.²

The WisdomTree U.S. SmallCap Quality Dividend Growth Fund (DGRS) is designed to track the total return performance of an index focused on higher-quality small-cap companies that all pay dividends.³ They also have relatively higher return on equity and return on assets measures.

Therefore, we can look at:

• IWM as a broad-market benchmark with significant exposure to more speculative small-cap stocks.
• DGRS as a more focused strategy on U.S. small caps that emphasizes the higher-quality angle.

For those investors considering that the speculative rally may end, we wanted to focus on two of the following figures. Figure 3a indicates the valuation discount, on multiple metrics, of DGRS relative to IWM.

Figure 3b indicates the return on equity and return on assets of DGRS versus IWM.

Figure 3a: DGRS Shows a Valuation Discount on Multiple Measures against IWM

Figure 3b: DGRS Shows Significantly Higher Quality Metrics than IWM

If the trend shifts back to rewarding higher-quality small caps, we think that DGRS may be particularly well positioned.

Figure 4: Additional Information

¹ Source: "Small-cap stocks gain momentum: A new era of retail-driven growth and earnings optimism," AInvest, 10/25/25.

² Sources: WisdomTree, FactSet, Morningstar, with data accessed as of 11/6/25 within WisdomTree's Fund Comparison tool.

³ This index is the WisdomTree U.S. SmallCap Quality Dividend Growth Index.