A recent research report published by John Hancock Investment Management sheds light on the performance of small-cap stocks, revealing some striking historical trends. Traditionally, these smaller companies have outperformed their larger counterparts, particularly regarding average returns. This report emphasizes the unique behavior of small-cap stocks within diversified portfolios, suggesting that they can serve as effective diversifiers due to their differing characteristics compared to large-cap stocks.

The study closely examined the existence of size premiums in the U.S. stock market, drawing on the historical performance of the well-regarded Fama/French U.S. Small and Large Cap portfolios. Findings from this research indicate that since the 1920s, small-cap stocks have consistently outperformed large-cap stocks over various market cycles. Supporting these conclusions, another study by Invesco in 2020 highlighted that small-cap stocks have outpaced large-cap stocks across four recessions, achieving superior performance in all but one of the subsequent 1- and 3-year periods.

One of the key factors contributing to the appeal of small-cap stocks is their significant growth potential, which analysts highly value. As these businesses typically reside in the early stages of growth, they have more room for substantial increases in stock value, making them attractive to investors. Another reason investors may consider small-cap stocks is their inherent volatility, which can lead to short-term trading opportunities and price swings that savvy investors can exploit. Additionally, many small-cap companies operate in specialized or niche markets, which can allow analysts to leverage unique business models that, if successful, could yield impressive returns.

Moreover, small-cap stocks often emerge as prime targets for mergers and acquisitions, creating additional reasons for investor confidence. Analysts closely monitor these stocks with the expectation of potential buyouts, which often results in increased share prices.

Defined by a market capitalization ranging from $300 million to $2 billion, small-cap stocks tend to be more volatile and riskier than their large-cap counterparts. However, historical trends suggest that these smaller stocks have often outperformed large-cap stocks over time. For example, during the tech bubble of the 1990s, large-cap stocks dominated the investment conversation until the bubble burst in March 2000, after which many small-cap companies showcased superior performance.

Ultimately, while stock performance isn't solely dependent on size—larger or smaller—it's essential to consider both macroeconomic and microeconomic factors influencing a business. Often overlooked by Wall Street analysts, small-cap stocks may be undervalued, presenting investors with solid return opportunities.

In a market that often focuses heavily on high-cap powerhouses, knowing when to invest in the right stock at the right time and price becomes crucial. Investors should take a moment to ponder whether the stocks they are pursuing are genuinely worth the investment or if they might be missing out on high-growth small-cap stocks.

Francis Gannon, Co-Chief Investment Officer at Royce Investment Partners, elaborates on this point by saying, “We recently published a list of 10 Small Cap Stocks with Huge Upside Potential.” In this context, we will delve into the performance of Applied Optoelectronics, Inc. (NASDAQ:AAOI) and see how it compares with other small-cap stocks boasting substantial upside potential.

To determine the right small-cap stock for your portfolio, it is critical to closely monitor not just individual stocks but also their industry peers, as this provides a more comprehensive overview. Key factors to consider include liquidity position, sensitivity to market fluctuations, financial stability, and connections to emerging technologies like artificial intelligence (AI). The stocks identified in our analysis promise high upside potential across diverse sectors, including finance, food, and mining.

Our Methodology

Utilizing Finviz and Stock Analysis screeners, we selected ten stocks with market capitalizations between $300 million and $2 billion. Price targets for one year were sourced from Yahoo Finance, allowing us to assess upside potential based on stock prices as of March 28, 2025. These companies were then ranked according to their upside potential.

At Insider Monkey, we maintain a strong interest in hedge funds. Our research indicates that mimicking the stock selections of top-performing hedge funds can lead to market outperformance. Our quarterly newsletter adopts a strategy that selects 14 small-cap and large-cap stocks each quarter, achieving an impressive return of 373.4% since May 2014 and significantly beating its benchmark by 218 percentage points.

Is Applied Optoelectronics, Inc. (AAOI) The Small Cap Stock with Huge Upside Potential?

A technician is observed working with a complex fiber-optic networking setup in a laboratory environment.

Applied Optoelectronics, Inc. (NASDAQ:AAOI)

Upside Potential: 133%
Market Capitalization: $823.092 million

Based in Texas, Applied Optoelectronics, Inc. (NASDAQ:AAOI) specializes in providing fiber-optic networking products. As a vertically integrated company, it engages in the design and development of a variety of optical communications offerings, including advanced optical devices, laser transmitters, cable television services, point-to-point communications, and both wireless and hybrid fiber-coaxial (HFC) networking solutions. Established in 1997, the firm is committed to revolutionizing communication by enhancing global connectivity.

Recently, Applied Optoelectronics, Inc. drew attention with its agreement with Amazon, allowing the tech behemoth to acquire up to 8 million shares of the company. Although specific terms of the deal have not been disclosed, it signals that AAOI is positioned for significant growth ahead.

The company's Q4 2024 earnings report highlighted improved performance, showcasing revenue and gross margins within the anticipated range. This growth was primarily driven by demand for its 400G products and CATV segment, along with an expansion of production capabilities. Management also revealed that they received a substantial order for Quantum Bandwidth networking products from a leading North American cable operator, with shipping commencing this month and expected to contribute positively to upcoming financial results.

In response to the growing demand for domestic production to meet stringent data center requirements, Applied Optoelectronics, Inc. is establishing a new production facility in Texas, with plans for further expansion in Taiwan to strengthen its global footprint.

The rising demand for AAOI’s cloud computing infrastructure and data centers signals a bright future, potentially driven by significant orders from major clients like Amazon. The company's one-year price target stands at $38.20, suggesting an impressive upside potential of 133%, which supports our optimism about its prospects. Ranking fourth on our list of small-cap stocks with substantial upside potential, we believe that AAOI holds promise for investors, although we maintain that certain AI stocks may offer even greater returns over a shorter period.

For those exploring investment opportunities, we encourage looking into an AI stock that has experienced growth since the beginning of 2025, especially considering the performance of popular AI stocks that have dipped by around 25%. For those interested in an AI stock trading at less than five times its earnings, be sure to check out our report on this promising and undervalued opportunity.

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