In a Mega-Cap World, This Micro-Cap Fund Has Delivered Decades of Outstanding Returns

Key Takeaways

• With an average annual return of 12.4%, the Oberweis Micro-Cap Fund is the fifth-best-performing US stock fund of the past 25 years.
• The fund uses a strategy based on an investing phenomenon called post-earnings announcement drift.
• While the management team looks for growth, it still keeps an eye on stock valuations.

While the market has been dominated by multi-trillion-dollar names like Nvidia NVDA and Microsoft MSFT, the Oberweis Micro-Cap Fund OMCIX has found success investing in some of the smallest stocks.

Instead of the tech behemoths powering the artificial intelligence trade, the $907 million fund invests in stocks with a market cap between about $100 million and $2.5 billion, across the range of micro-cap and small-cap companies. The Oberweis Micro-Cap Fund’s institutional share class earns Morningstar’s highest medalist rating of Gold, owing to its sound investment process and strong management team.

“We are fishing in a pond that is more fruitful than other parts of the US equity market,” says Kenneth Farsalas, who has been portfolio manager of the fund since 2015. “In the micro-cap space, you have less research coverage, less eyeballs on these companies, and less institutional sponsorship. So these are companies that are less known than the mid-cap and large-cap companies that dominate the headlines.” To find winners, the fund looks deeply at earnings results, valuations, and competitors’ research for underappreciated companies.

The fund looks for companies with higher growth than their micro-cap peers. Originally, the strategy invested in the smallest companies with the highest absolute growth, but that changed to a relative growth strategy in 2015, when Farsalas became head portfolio manager. He says this is the only major change to the fund’s strategy since its inception in 1996, though the team has tweaked details.

To find high-growth investments, Farsalas looks for firms with a higher adjusted net income than competitors in their sector or industry, but he doesn’t neglect other metrics, such as free cash flow. The Oberweis fund combines its search for relative growth with insights from behavioral economics and a value-conscious process, all of which have combined to deliver stellar long-term results. In the 25 years ending in 2025, the fund returned an average of 12.4% a year, the fifth highest of all US stock funds, excluding sector funds and those with under $100 million in assets.

A Fruitful Strategy: Focusing on Post-Earnings Announcement Drift

The strategy has a major focus on exploiting a phenomenon known as post-earnings announcement drift. “PEAD is the tendency of a stock’s price to drift higher in the direction of a positive earnings surprise for a year or longer,” says Farsalas. “When an earnings surprise is based on a tangible and profound fundamental change in a business, investors systematically underreact to that change and don’t fully appreciate the business looking forward.”

Farsalas says investors are relatively slow to change their view of a business due to cognitive biases that won’t recalibrate immediately, even in light of new information. This means if there is a significant and durable improvement in a business, it will take time for investors to recognize it. As they do, more buy the stock, leading to a predictable upward drift in its price.

Accordingly, the first step in the fund’s stock-picking process is identifying companies that have announced quarterly earnings above the consensus expectation (usually by 10% or more) and received an accompanying positive reaction from the market. Next, managers research whether the surprise was caused by a one-off event or a significant change in the business, such as new management or a new product line.

One such example is the fund’s purchase of shares in theater systems company IMAX IMAX in March 2024 at $17 per share. Farsalas’ team bought the shares after a 240% earnings surprise. “While theaters have lost market share to streaming, IMAX has taken share, because when people do venture out to the theater, they want to see the film in a premium setting,” says Farsalas. “IMAX got stronger during the pandemic, and they’ve generated earnings surprises in six of the last seven quarters. We still owned a healthy position at year-end.” IMAX stock ended the year trading at $37 per share.

Farsalas says the fund invests with a one-to-two-year time horizon, as that is typically the amount of time that PEAD lasts. In addition, he doesn’t believe it’s possible to make predictions much further than that. “I can tell you from experience that you can’t look far out when you’re looking at micro-cap companies. They’re very volatile.”

Earnings Quality: Filtering Out the Micro-Cap Junk

The focus on earnings surprises also helps the fund filter companies for quality—something often lacking in the micro-cap space. “There’s a lot of junk in the micro-cap space. Lots of these companies have no business being public,” says Farsalas. “Our focus on earnings surprises steers us away from that junk.”

Junky companies include those with overly debt-laden balance sheets or poor profitability, among other factors. “When we’re doing a financial statement analysis, if the balance sheet is a mess, and their company is burning cash, that’s a reason for us not to invest, and we stop researching right there,” Farsalas says.

A positive earnings surprise usually means either that a company had a one-off or accounting-related boost in their profits, or that their business changed in a significant way. Much of the early work team does has to do with verifying whether there’s a substantial business change that will endure for future quarters.

Digging Deeper: A 17-Step Process

Farsalas says the firm goes through a 17-step proprietary fundamental research process to create an estimate of a firm’s future growth. Only after doing this will they look at external research to see what other analysts are saying about the stock. The Oberweis team will not proceed unless their view differs substantially from the consensus of other analysts.

“You can’t beat the market if you’re the same as the market,” says Farsalas. “We’re looking for misunderstood companies.” This ties back into the fund’s focus on behavioral economics. He thinks that too many firms hew too closely to consensus numbers in a herd mentality that blinds them to unappreciated opportunities.

Valuation-Conscious Growth Investing

Finally, the Oberweis Micro-Cap Fund looks to ensure that a stock is at a low price before investing. Farsalas’ team determines a stock’s valuation based on growth estimates they’ve formed earlier in the process.

“We won’t just pay any price for growth,” says Farsalas, who believes this is a major factor that distinguishes the fund from its growth-stock fund peers. “There are a lot of growth investors out there who don’t pay too much attention to valuation,” he says. “I started my career in the mid-’90s and learned early on that the price you pay for growth is important … I got my teeth kicked in during the internet bubble.”

He continues: “We have an entire generation of growth investors who have no idea that valuation is meaningful. If you grew up in this business in 2009-21, when interest rates were zero and the Fed was printing money to infinity, you grew up in a highly abnormal period relative to market history.” With interest rates at 3.50%-3.75% even after multiple cuts from the Federal Reserve, Farsalas says the zero-rate world is over.