Tom Maher on Small-Cap Investing, AI Infrastructure and Opportunities Beyond Big Tech

Tom Maher · Hilton Capital Management

Small and mid cap earnings are expected to grow 20-30% over the next few years alongside strong GDP.

Maher expects 20 to 30 percent earnings growth in the small and mid cap space over the next few years. He says this fits with what looks like very strong GDP growth. Part of the earnings growth comes from revenue, especially in technology and industrials tied to the AI build-out, and part from margin improvement, since top-line growth alone does not explain the earnings growth he expects. He says this is what gives him a reason to be on the gas pedal.

“You have 20, 30% kind of earnings growth expected over the next few years, and that sort of jives with what looks like very strong GDP growth at the same time.”at 3:05

Tom Maher · Hilton Capital Management

Extreme mega-cap concentration makes a case for diversifying into small and mid caps.

Maher says one or two of the Magnificent Seven had more market cap than his entire small and mid cap universe. He argues this extreme concentration is a reason investors may want more diversification, which would lead them to small and mid caps. He notes that passive investing has pushed a lot of money into those stocks, creating a self-reinforcing cycle. A trickle of money out of large-cap holdings would be large relative to the small-cap market, which he sees as a supply-and-demand tailwind.

“there is something to be said about that extreme concentration in these stocks.”at 9:52

Tom Maher · Hilton Capital Management

Small caps' valuation premium depends on the individual company's business model, not on size.

Maher says small caps currently trade at lower multiples than large caps, so he does not see a size premium built into the market today. Where a premium exists, it is company-specific. He gives an example from the electrical connector industry, where two near-identical peers had very different valuations because one ran its factories as independent fiefdoms with separate P&Ls. That difference in business model, not size, drove the premium. He says a premium is most likely for the rare small caps that graduate to a larger size.

“what I found in my experience is that there are some that carry that, but I think it has more to do with an individual company than it being a small cap.”at 17:06

Tom Maher · Hilton Capital Management

Rising unprofitable companies in the Russell 2000 lower the index's overall quality.

Maher agrees the Russell 2000 has deteriorated in the sense of change, and says the growing share of unprofitable companies lowers aggregate quality. These firms are not self-funding and depend on external capital, so they are vulnerable if conditions tighten or rates rise. He links this to private capital: because so much money is available privately, promising technology and biotech companies can stay private and avoid the cost of going public. That leaves a public small-cap pool with more unprofitable names and fewer new quality IPOs.

“suggests the overall aggregate quality is a little bit lower because, again, some of these are not self funding businesses, and they're reliant on external funding.”at 24:37

Tom Maher · Hilton Capital Management

Neglect of non-AI parts of the market has pushed small-cap valuations down to attractive levels.

Maher argues that the market's fascination with AI, which he calls the one shiny object, has left many other parts of the market neglected. As a result, valuations have fallen to levels where he can look at these companies again. Small and mid caps had been left in the wilderness, but he sees a little more focus returning, and he hopes it will improve. He says a stock trading at a middling level versus its ten-year valuation history does not need to shoot the lights out to be a good investment. Valuations are his entry point, combined with earnings growth. He still needs to see fundamental improvement.

“when the market become fascinated with one shiny object, which has been AI, a lot of other parts of the market become sort of neglected, and and the valuations have come down to a level where, hey. I can look at these companies again.”at 1:03:37

Tom Maher · Hilton Capital Management

The AI build-out is a major GDP and capex driver, with ancillary follow-on businesses still to come.

Maher calls the AI build-out the first and most obvious positive trend in the market. He argues it is a significant driver of GDP growth, with a massive amount of capex flowing through the economy, and that the ancillary businesses that follow should benefit. He also says companies building the AI build-out, or supplying non-IT hardware and equipment into it, have seen some of the most impressive upward earnings revisions in industrials. He frames the build-out as a multi-year theme, though he does not put a number on it.

“the AI build out... that's a significant driver of GDP growth, a massive amount of CapEx coming through, and then all of the ancillary sort of follow on businesses that should spring from that.”at 2:50

Tom Maher · Hilton Capital Management

AI build-out is lifting industrial suppliers, such as parts makers for liquid cooling, in concentric circles.

Maher sees part of the industrial recovery as ripples from the AI build-out. He cites suppliers making parts for liquid cooling and equipment that goes into data centers, along with cat-type construction equipment, which rose sharply. He says these concentric circles around the AI theme benefit from the macro driver. His fund owns companies in those equipment and construction spaces that got in front of the AI trend, and he uses this thematic approach to find ideas rather than buying AI names outright. He also notes that many CEOs want to talk only about AI even when it is a small share of their business.

“some of this is sort of the the ripples out from the AI build out... you have the companies that supply parts to companies that are making the liquid cooling. All of that sort of concentric circles are certainly benefiting from that big macro driver.”at 1:04:08

Tom Maher · Hilton Capital Management

AI-linked stock multiples were barely scrutinized in Q2, then unwound quickly in Q3; some are froth.

Maher says multiples can compress or expand quickly when the market is trying to price the magnitude of changes like the AI build-out. In Q2, almost no one scrutinized valuations of companies even partly tied to the AI build-out. In Q3 those multiples rapidly unwound. He says part of the multiple reflected mania-like froth. Once that excess is stripped away, earnings growth may still be enough to support the stocks, even if growth has peaked in acceleration.

“In the second quarter, there was very little scrutiny put on any valuation if you were even remotely or partially related to the AI build out. And then as you entered the third quarter, that rapidly unwound.”at 5:38

Tom Maher · Hilton Capital Management

AI-related stocks had a manic blow-off phase and now face a revaluation as rates rise.

Maher says the quarter began after a manic blow-off phase in some AI-related names. The market then turned to a 'wait, maybe that's the peak' view, as acceleration appeared to have peaked and the group was due for revaluation. Persistent inflation and a Fed that was adding to pressure then compounded the issue. This framing treats the AI rally as stretched and vulnerable to a rate-driven repricing. The argument is brief, and he gives no firm numbers.

“after the sort of manic blow off phase in some of the AI related names, now we have this sort of, well, wait... We've seen maximum acceleration, and we... You're gonna sort of, you know, revalue all those stocks.”at 36:17

Tom Maher · Hilton Capital Management

Mainstream US industrial demand is recovering, with the ISM rising and heavy-haul trucking loads picking up.

Maher says the ISM was under 50 for a long period and is starting to perk up. He sees this in companies that supply machinery and other equipment to industry. He also hears from truckers that unsided and heavy-haul loads are picking up, which he says usually signals an industrial economy beginning to build. He adds that reshoring and US manufacturing buildup, along with AI construction, must be executed domestically, and small and mid caps are where that work will be captured.

“unsided or heavy, haul loads are starting to pick up. Those are usually indicative of some industrial economy starting to build.”at 7:19

Tom Maher · Hilton Capital Management

US industrial activity is gradually reviving as firms reshore supply chains to build resilience.

Maher says his firm started seeing improvement toward the end of last year or the start of this year. Trucking companies in his portfolio report more oversize and heavy-haul freight, which moves industrial equipment, and he treats that as a sign of activity. He credits three shocks for pushing firms to become more resilient and less globalised: COVID, tariffs that snarled supply chains, and the war involving Iran, which disrupted fuels and other commodities. He thinks these shocks were a bigger motivation than policy. Full first-year depreciation helps but is not the main driver. The gains are gradual, with growth rates improving from modestly negative to positive, and not an eye-catching surge.

“What it is, sort of manifesting is is a gradual improvement in growth rates, some from minus... Modestly negative to positive, some from, you know, modestly positive to a little bit higher positive on on the scale.”at 1:03:14

Tom Maher · Hilton Capital Management

The US economy is strong relative to the rest of the world, which argues for disproportionate US exposure.

Maher says the US economy seems fairly strong relative to the rest of the world. In his view, that argues for disproportionate US exposure, which he says a portfolio can get more readily through small caps than through mega caps. He combines this with the AI and reshoring build-out in the US, and with a desire for diversification, as reasons to favor small and mid caps.

“The US economy seems to be pretty strong relative to the rest of the world right now, so that would lead you to wanna have probably, you know, disproportionate exposure here, in my opinion.”at 10:23

Tom Maher · Hilton Capital Management

The best IPOs will likely be priced above his valuation range until they grow into earnings.

Maher says the IPO pipeline matters less to his small-cap portfolio than to growth investors. He says most of the good companies coming public will probably be priced out of his valuation range until they grow into their earnings. He expects private-equity-backed companies to come out in the mid-cap space as they look for exits, so the IPO pipeline may be delayed rather than gone for good. He also says that scrutinizing those offerings will require active management.

“Most of the really good ones coming as IPOs are probably gonna be priced out of my range until, you know, they sort of grow into their earnings a bit.”at 25:58

Tom Maher · Hilton Capital Management

Higher rates will stress small caps with heavy floating-rate debt and speculative names with rich multiples.

With the ten-year yield near a nineteen-year high and inflation persisting, Maher expects more stress on small and mid caps with high balance-sheet debt, more floating-rate debt, or reliance on external financing. Quality should matter more. His own holdings are typically less levered and self-funding, so he thinks the impact on his portfolio is limited. Speculative holdings should face a harder run because the market is less willing to let multiples run. Higher rates also mechanically compress multiples, hitting non-earners and very high-valuation stocks hardest. Banks and float-earning businesses are affected in opposite directions by rate changes.

“I think that that would be more stress on companies, obviously, with higher balance sheet debt, more floating rate debt, or more reliance on external financing.”at 36:47

Tom Maher · Hilton Capital Management

Passive ETF baskets make small caps move with their theme cohort, not their own fundamentals.

Maher says passive investing has clearly affected markets. Low interest rates and near-free capital let weakly justified business models keep raising money, and index funds benefited from that for a long time. He describes a mechanism in thematic ETFs: a small cap placed in a basket such as AI build-out gets pulled along with larger names as money flows in. It can then massively outperform, even though it is less liquid. The reverse also happens. A stock in a basket that is being shorted can be hit disproportionately for six to twelve months, regardless of its fundamentals. Investors need to work out why their stocks are moving. Tactically, that creates opportunities.

“If you get one of my stocks into a basket that is, you know, AI build out or whatever it may be, and the rest of them are larger cap stocks, as money flows into that, the small cap stock may massively outperform because it's getting pulled along with all the money as it comes in.”at 42:15