The Russell 2000 (^RUT) is home to many small-cap stocks, offering investors the chance to uncover hidden gems before the broader market catches on. However, these companies often come with higher volatility and risk, as their smaller size makes them more vulnerable to economic downturns.

Picking the right small caps isn’t easy, and that’s exactly why StockStory exists - to help you focus on the best opportunities. That said, here are three Russell 2000 stocks to avoid and better alternatives to consider.

Applied Digital (APLD)

Market Cap: $6.10 billion

Pivoting from its origins in cryptocurrency mining to become a key player in the AI infrastructure boom, Applied Digital (NASDAQ: APLD) designs and operates specialized data centers that provide high-performance computing infrastructure for artificial intelligence and blockchain applications.

Why Are We Hesitant About APLD?

1. Incremental sales over the last two years were much less profitable as its earnings per share fell by 83.8% annually while its revenue grew
2. Capital intensity has ramped up over the last five years as its free cash flow margin decreased by 54.3 percentage points
3. Short cash runway increases the probability of a capital raise that dilutes existing shareholders

Applied Digital’s stock price of $20.29 implies a valuation ratio of 53.4x forward EV-to-EBITDA. Check out our free in-depth research report to learn more about why APLD doesn’t pass our bar.

Xerox (XRX)

Market Cap: $299.6 million

Pioneering the modern office copier and inventing technologies like Ethernet and the laser printer, Xerox (NASDAQ: XRX) provides document management systems, printing technology, and workplace solutions to businesses of all sizes across the globe.

Why Should You Dump XRX?

1. Annual sales declines of 2.6% for the past five years show its products and services struggled to connect with the market during this cycle
2. Sales were less profitable over the last five years as its earnings per share fell by 15.6% annually, worse than its revenue declines
3. High net-debt-to-EBITDA ratio of 8× could force the company to raise capital at unfavorable terms if market conditions deteriorate

Xerox is trading at $2.35 per share, or 2.8x forward P/E. To fully understand why you should be careful with XRX, check out our full research report (it’s free for active Edge members).

Merchants Bancorp (MBIN)

Market Cap: $1.40 billion

With a strategic focus on low-risk, government-backed lending programs, Merchants Bancorp (NASDAQCM:MBIN) is an Indiana-based bank holding company specializing in multi-family mortgage banking, mortgage warehousing, and traditional banking services.

Why Does MBIN Worry Us?

1. Weak unit economics are reflected in its net interest margin of 2.9%, one of the worst among bank companies
2. Operational productivity has decreased over the last five years as its efficiency ratio worsened by 13.6 percentage points
3. Tier one capital ratio of 8.9% raises concerns about the firm’s ability to maintain adequate liquidity

At $30.49 per share, Merchants Bancorp trades at 0.7x forward P/B. Read our free research report to see why you should think twice about including MBIN in your portfolio.

Stocks We Like More

If your portfolio success hinges on just 4 stocks, your wealth is built on fragile ground. You have a small window to secure high-quality assets before the market widens and these prices disappear.

Don’t wait for the next volatility shock. Check out our Top 6 Stocks for this week. This is a curated list of our High Quality stocks that have generated a market-beating return of 244% over the last five years (as of June 30, 2025).

Stocks that made our list in 2020 include now familiar names such as Nvidia (+1,326% between June 2020 and June 2025) as well as under-the-radar businesses like the once-micro-cap company Tecnoglass (+1,754% five-year return). Find your next big winner with StockStory today for free. Find your next big winner with StockStory today. Find your next big winner with StockStory today

StockStory is growing and hiring equity analyst and marketing roles. Are you a 0 to 1 builder passionate about the markets and AI? See the open roles here.