Small-caps have been on a tear this year clearly outperforming its larger counterparts. Small-cap fund iShares Russell 2000 ETF (IWM - Free Report) is up 9.4% this year while the S&P 500-based fund SPY is up about 2% (as of Jun 21, 2018).
Though large-cap index S&P 500 started 2018 on a better footing than the Russell 2000, the game started changing from mid-March. President Trump’s protections agenda and the resultant trade war fears started weighing on large-cap stocks that have a considerable international exposure. And the domestically focused pint-sized stocks soared.
Since mid-March, there was no looking back for the Russell 2000 index, having outperformed its mid (Russell Midcap index) and large-cap (Russell 1000 index) counterparts for the third straight month through May. So far this month, small-caps have clearly beaten large-caps (read: 5 Hottest Small-Cap ETFs of 2018).
In additions to trade tensions, there were some other factors that played their roles in pushing pint-sized stocks higher. The U.S. economy has been on steady ground. This gave a boost to small-cap equities. Apart from this, upbeat earnings sent small caps rallying in recent times.
The tax reform is yet another tailwind to the segment as it is supposed to favor small-caps more. This is because companies on the Russell 2000 pay a higher median effective tax rate than the S&P 500, per Thomson Reuters. Now the question that arises is how long the rally will continue (read: Why Leveraged Small-Cap ETFs Are Going Through the Roof).
Is the Rally Triggering an Overvaluation Concerns?
Per Bloomberg, small-cap stocks are trading at an average of about 26 times their expected earnings during the next year. On the other hand, large-company stocks in the S&P 500, are trading at a much cheaper valuation of 17 times.
Agreed, small-caps normally have higher valuation due to higher expected growth rates, but many may start seeing overvaluation issues in some small-cap stocks. After such a strong rally, profit booking activity seems normal.
Given this, we would like to highlight some top-ranked small-cap ETFs that have historical P/E less than that of the average small-cap stocks (read: 6 Smart-Beta Small-Cap ETFs to Pick if the Rally Softens).
First Trust Small Cap Core AlphaDEX ETF (FYX - Free Report) ) – P/E 13.96x
The 525-stock fund puts double-digit weights in Industrials (18.4%), Consumer Discretionary (16.17%), Health Care (14.99%), Information Technology (14.60%) and Financials (13.80%). No stock accounts for more than 0.53% of the fund (read: Q1 GDP Growth Beats Estimates: ETFs to Buy).
Vanguard Small-Cap Value ETF (VBR - Free Report) ) – P/E 16.10x
The 888-stock fund has double-digit weights in Financials, Industrials and Consumer Services. The fund charges 7 bps in fees. The top individual holding of the fund gets 0.60% of the fund.
Small Cap US Equity Select ETF (RNSC - Free Report) ) – P/E 19.20x
The fund holds 346 stocks in the basket with no stock accounting for more than 2.48% of the portfolio. The fund has double-digit weights in Industrials, Financials, Health Care, Consumer Discretionary and Information Technology. The fund charges 60 bps in fees.
Schwab U.S. Small-Cap ETF (SCHA - Free Report) ) – P/E 19.35x
The fund has double-digit weights in Financials, Information Technology, Industrials, Health Care and Consumer Discretionary. In total, the fund holds more than 1,700 stocks. It has an expense ratio of 0.05%.
Vanguard Russell 2000 ETF (VTWO - Free Report) ) – P/E 19.70x
The 2005-stock fund puts double-digit weights in Financials (24.9%), Health Care (16.7%), Technology (14.4%), Consumer Discretionary (13.5%) and Producer Durables (13.4%). The fund charges 15 bps in fees.
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