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Grab a Slice of the Discounted Small-Cap Pie

Small-cap companies are currently trading at big discounts versus their large-cap peers, proving investors can still find those pockets of opportunity in the middle of a pandemic recovering economy, reported the Financial Times.

The gauge that tracks the S&P 600 is currently priced at 14.5 times expected earnings for the next year, far below the S&P 500’s expected 21.3 times —the S&P 500 includes the major stocks such as Facebook, Alphabet, Tesla, and others.

Image source: Financial Times

This means that the price-to-earnings ratio for the S&P 600 is approximately 68% of the S&P 500, the lowest it’s been since the dot-com bubble in the early 2000s. With investors focusing mainly on growth stocks across all caps, small cap value stocks are priced at even greater discounts, according to William Heaphy, head of value equity team for William Blair.

With valuations doubling across all market caps from the pandemic crash in March 2020, investors have to pay higher for large-cap exposure, and valuations for the biggest companies are currently considered to be highly elevated compared to trends over the long term. It’s left a bubble of opportunity for investors and advisors within small caps that analysts and advisors are noticing.

“Despite our forecast for a flat year for the S&P 500, we are still bullish on pockets of the market, including small caps,” said analysts at Bank of America in their outlook for 2022 for Wall Street. “Small caps are more domestic, more exposed to the services spending recovery, bigger beneficiaries of capital spending and ‘reshoring,’ and are inexpensive [compared with]large caps.”

Small Cap Investment with AVUV

American Century Investments, partnering with Avantis Investments, offers the Avantis U.S. Small Cap Value ETF (AVUV), an ETF that invests in small-cap companies with low valuation but high profitability ratios.

An actively managed ETF, AVUV combines the typical benefits of following an index — diversification, low turnover, and transparency of exposures — with the flexibility to capture price movements as they happen, and advisors are increasingly investing because of the methodology according to American Century.

The fund uses the Russell 2000 Value Index for benchmarking purposes, which tracks the 2,000 smallest-capitalization stocks of the larger Russell 3000 Index, but the ETF does not replicate this index.

AVUV’s portfolio managers use fundamental screens such as shares outstanding, cash flow, expenses, revenue, and book-to-value to select stocks. Smaller companies with high profitability are weighted more heavily than those with lower returns and higher prices.

In addition, AVUV can also invest in derivatives, such as futures contracts, currency forwards, and swap agreements, to gain exposure to equities and manage cash flow.

As of the end of November, some of the top sector allocations for the fund include financials at 29%, consumer discretionary at 17%, and industrials at 17%.

AVUV has an expense ratio of 0.25%.

For more news, information, and strategy, visit the Core Strategies Channel.

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