Big stocks are Wall Street’s bread and butter, but it’s often the smaller, overlooked equities that offer regular investors the most upside. Consider that in the past five years, small stocks (as measured by the Russell 2000 Index) have outperformed the S&P 500, rising 7.2 percent annually vs. 5.4 percent for the biggies. To help us scout out some small-stock values, we turned to Thomas Laming, lead manager since 2010 of Scout Small Cap Fund (UMBHX, 800-996-2862). Based in Kansas City, Tom is a former aerospace engineer who joined Wall Street in the late 1980s. Below, Tom tells us about a few companies he thinks have demographics and tech trends on their side, yet remain undervalued.

Are you concerned about the Federal Reserve ending its monetary stimulus? Some think this will cause interest rates to rise, hurt the economy and crush small stocks.

Not really. Historically, small stocks have performed far better when interest rates are rising, since rising rates often go hand-in-hand with stronger economic growth.

What is your outlook for the US economy?

A plus for the economy is that government spending as a percentage of GDP is being lowered. Government contractors aren’t in a good spot now because of this. But the equity of the entire country is probably improving because spending is being shifted back into the hands of owners – corporations and individuals – who tend to make more efficient decisions about how to spend their money.

We have big deficits and large amounts of debt here in the US, like most other developed countries. So it’s not a bad thing when government spending is being ratcheted down.

Investors were quite worried about sequestration, but the market kept powering through that. It seems the shift in the spending mix is being recognized as a good thing.

Why do small-caps outperform when interest rates are rising?

We went back and looked at what happened to equities from the end of 1962 through 2007, which marked a perfect roundtrip in terms of interest rates; rates started at 4 percent (the yield on 10-year Treasuries), got up to about 16 percent, and then came back down to 4 percent.

Over this period, small-caps far outperformed. And when we looked more closely at this period and considered company-specific performance, there are a few things that standout.

First of all, small companies are more apt to be equity financed, since they’re generally cut off from the bond market because of their size. During a period of rising rates, many large companies have to refinance, year after year at higher rates, which we saw throughout the 1960s and 1970s. That’s probably one of the reasons why large companies underperformed.

The second reason is a bit more subtle, and it has to do with risk premium. When rates are rising, it’s often because the economy is doing better and might even be overheating. In that environment, people flock to riskier investments, and so they’re willing to pay more for small-cap stocks. As a result, the price-earnings ratios on small caps expand faster than those of big stocks.

The last factor is even harder to measure, and it has to do with rising energy prices. Big companies tend to be more energy dependent than smaller ones, and so their earnings get dinged by rising energy prices. We saw this in a big way throughout the 1970s and into the early 1980s.

Small stocks actually performed better in the rising-rate environment between 1962 and 1981, than they did across the entire period. I don’t think this will always be the case. However, small stocks do seem to be more immune to rising rates compared to large caps.

How do you find promising small-cap stocks?

Our approach starts with a top-down analysis, trying to identify good growth drivers that are technological, demographic, or some other catalyst that is on the verge of being widely recognized.

Then we always follow up with a valuation process to make sure we’re not overpaying. The top-down part of our process helps us avoid value traps by identifying the fast-growing parts of the economy, while the bottom-up screening ensures that we don’t overpay for the growth we think we’ve found.

Can you apply your approach to a specific stock, for us?

Sure. We know that natural gas is a cleaner-burning fuel, and that its advantage over coal is permanent. So we make it a point to single out companies like Chart Industries (NSDQ: GTLS), which gets a tailwind from the push for lower emissions. Chart builds facilities that convert natural gas into liquid form, so it can be transported domestically and also exported. Regardless of the price of natural gas, we think Chart is in a great position to continue growing.

So why not invest in natural gas producers themselves?

The short answer: we don’t think there’s good reason to expect rising commodity prices. While we do own some materials companies, we like them because of their technological advantages in extraction or transportation rather than for their actual production.

People are conditioned to think that economic growth is what leads to higher commodity prices. However, you can have growth and weak prices at the same time. For instance, we had tremendous growth in the 1980s and 1990s, yet oil ended up at $11 a barrel.

I think commodity prices, most of which are quoted in dollars, are much more dependent on US monetary policy and the strength of the dollar, than on peak supply estimates or demand from China and India. A lot of people are investing in commodities now in the hope that China’s consumption of commodities will increase. But this type of thinking can get you into trouble.

The US economy is slowly improving, and it’s in better shape than Europe or Japan. This could well lead to a stronger dollar, driving commodity prices down.

What other types of companies are you investing in now?

We own Weight Watchers International (NYSE: WTW), which Wall Street has been very impatient with lately due to flat revenue and lower profits. It’s true that WTW’s business is shifting to its online channel, weightwatchers.com. The online business has higher margins and it’s been growing 28 percent annually since 2008. However, the online space opens up WTW to more competition and to slower growth in its offline business. But we think this problem is solvable.

The company has a very strong, trusted brand worldwide. Every week, it holds some 50,000 meetings attended by 1.3 million people.

We also think there’s some built-in unit growth in this market. Studies show that obesity rates for women rise as they get older (even though they actually fall for men over 60, probably because more men die from heart attacks).

So part of what’s driving US obesity is an aging population. Weight Watchers is mainly used by women, a growing number of whom are over 60.

Weight Watchers is also an extremely strong cash generator. And it continues to use a good part of its excess cash flow to buy back its own shares. Undergoing a self-buyout, if you will, it has reduced its shares outstanding almost by half during the last decade, going from 110 million shares in 2001 down to 56 million today. That by itself is a driver of earnings per share growth.

LSI Corp (NSDQ: LSI) is at the intersection of two very strong longterm trends: growth in data networks and the need for storage.

The stock is cheap because telecoms and companies that run big data centers have cut back on spending. But we think this will change because the long-run drivers for why data centers are there to begin with is still in place.

People are increasingly watching news, videos and TV shows on smart phones and tablets; about 10 percent of Internet traffic, for example, is people watching videos on YouTube. As we get even better and faster cellular systems, there will have to be huge growth in bandwidth. As a result, the telecom providers will have to go out every few years and buy a lot of equipment from companies like LSI.

About 40 percent of LSI’s business comes from personal computer (PC) hard drives, and this is shrinking as PC demand slows. But LSI is also a big player in flash storage used in tablet computers and cell phones.

Close to 3,000 photos are uploaded to Facebook (NSDQ: FB) every second, and a lot of that is coming from tablets and smart phones with flash storage. So the long-term drivers for LSI are still in place.