Don’t give up on small cap stocks



A A little over a year ago, I said that small business stocks offer good value – they are not dead, as many believed.

Indeed, they woke up with a start. In less than six months – from September 24, 2020 to March 15, 2021 – the S&P 600 Small Cap Index rose 69%, more than triple the gain of the S&P 500 Large Cap Index.

Subsequently, however, lowercase returned to the pattern that has prevailed since 2014. Their prices leveled off over the next six months, while stocks of large companies continued to climb rapidly and consistently. It’s not that small caps have done badly over the past decade. Their returns are well in the double digits and are above historical averages. The problem is, in this bull market, the small companies have so poorly followed the big ones that one wonders if the gap is permanent.

Consider the Russell 2000, a popular small-cap index. Over the past five years, the large-cap Russell 1000 has beaten the Russell 2000 by an annual average of four percentage points and over the past 10 years by 2.6 points. These are serious differences, not least because historically small caps have significantly outperformed large caps.

To offset their greater risk, small caps have historically recorded higher returns. Except lately – despite this incredible six-month surge – they haven’t. Since 2014, Vanguard Russell 1000 (VONE), an exchange-traded fund linked to the large-cap index, has beaten the Vanguard Russell 2000 (VTWO), an ETF that tracks its analog small-cap index, in seven of the eight calendar years. , including so far in 2021. (Stocks and funds I like are in bold.)

Has something deep and lasting happened to small caps, or is this period an anomaly that may be reverting to the mean?

The case for large caps begins with overwhelming investor enthusiasm for S&P 500 index funds and the trillion dollar stocks that dominate these funds. Another change that favors large caps is that, as technology allows companies to go global, giant companies have a huge advantage, both in efficient supply chains and in marketing brands known around the world. . In addition, in this low interest rate environment, large companies can more easily access cheap money, which allows them to grow even more.

This business makes sense, but I look at investments from a different perspective. In the markets, investors avoid groups of stocks until those stocks become irresistible. Then they jump in and the prices go up. This is the phenomenon that fueled small caps from September 2020 to March 2021, proving that these stocks can still attract investors.

Good deals

Small caps offer undeniable value. According to Morningstar, the average price-earnings ratio of the Russell 2000 stocks that make up Vanguard’s ETF is only 16, compared to 22 for the Russell 2000 stocks. Vanguard Russell 1000 ETF. The average price to book ratio for the Small Cap ETF is 2.2, compared to 4.0 for the Large Cap Fund. The Russell 2000 ETF (IWM) has lower valuations despite higher long-term earnings growth.

Small caps also have other attractions. The S&P 500 has become almost an Internet specialty fund, with the computer science and Communication services sectors together representing 39% of the total index. These high-tech sectors represent only 16% of the small-cap S&P 600. Small-cap indices have the long-term advantage of being broadly diversified.

Plus, tech stocks aren’t the only ones to take off.

To take Crocs (CROX), a Colorado-based manufacturer of awkward but fashionable slip-on clogs. Recently, under imaginative management, the company has experienced impressive growth, with its shoes becoming especially popular with teenagers. When COVID hit, investors feared the worst and the stock lost half of its value. But since March 2020, the share price has risen by a factor of nine. (Take this, Apple!) Despite its dramatic rise, Crocs still posts a reasonable P / E of 20, based on analyst consensus on earnings estimates for the coming year.

Crocs has grown so much in value that, at nearly $ 9 billion, its market cap is no longer considered small. The generally accepted limit for a small cap stock is $ 2 billion, but that’s an old number and probably too low; I would update it to around $ 4 billion.

Under the radar

Because they are followed by fewer financial analysts, small cap stocks can go unnoticed and become undervalued. This may be the case with Calavo producers (CVGW), a distributor and distributor of avocados. Calavo’s stock, which is only hedged by five analysts and has a market cap of around $ 700 million, is down more than half from its 2018 high and offers a dividend yield of 3.0%, much more than a 10-year Treasury bill.

With a fleet of 247 aircraft, Bristow Group (VTOL) serves offshore energy companies and provides search and rescue work around the world. Although stocks have doubled since the summer of 2020 as oil prices rise, the stock, with a market cap of $ 966 million, is trading well below its all-time high.

Some of the best small cap funds are closed to new investors. Access is limited to my 2020 pick, Wasatch Ultra Growth, which has brought in 43% in the past 12 months. However, you can still buy stocks directly from the fund company or use their list of stocks, including Old wine estates (VWE), a Sonoma-based owner of over 30 premium wine brands. The action went public in April 2020 and is only followed by five analysts.

Many small-cap funds are disguised mid-cap funds. The average holding of Artisan Small-Cap, for example, has a market cap of $ 7 billion. This compares to $ 2.3 billion for SPDR S&P 600 Small Cap Wallet (MSPS), and $ 1.8 billion for another ETF that I like, WisdomTree US SmallCap Dividend (FROM). One of Artisan’s holdings is Ingersoll Rand (IR), with a market cap of $ 22 billion. Let’s go. While there is a place for large and mid-cap stocks in any portfolio, right now small is beautiful.

Some good and genuine managed small cap funds are open to everyone. A $ 10,000 investment in Buffalo Small Cap (BUFSX) 10 years ago, it would be worth around $ 49,000 today. Its number one asset is Everi Holdings (EVRI), a gaming technology company with a P / E of 21. Small Cap Growth AB (QUASX), founded in 1969, has recorded an annualized return of 27% over the past five years. (You can buy the fund without an initial charge from certain dealers.) Holdings include John Bean Technologies (JBT), which manufactures food processing equipment, and Trupanion (TRUP), which provides medical insurance for pets.

Few of the joys of investing surpass the joys of buying shares of a small company and seeing them end up skyrocketing. It’s not just the money, but the thrill of discovering stocks, in this era of mega-capitalization, that most people just find too small to notice.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



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