Home etftrends.com Quality Can Boost Allure of Small-Caps

Quality Can Boost Allure of Small-Caps

There’s been a lot of talk about the struggles of small-caps. But for the 12 months ending July 3, the average return posted by the widely followed Russell 2000 and S&P SmallCap 600 indexes was 8.3%. Though that lagged the large-cap S&P 500 by a wide margin, it’s not as if the small-caps gauges are in the red.

Still, investors are rightfully leery of allocating capital to smaller stocks and related ETFs. But relief could be on the way as a slew of market observers are wagering that the second half of 2024 will bring better things for small-caps. One way investors can position for a potential resurgence is by embracing higher-quality options, including the ALPS O’Shares US Small-Cap Quality Dividend ETF (OUSM).

Over the past year, OUSM beat the aforementioned small-cap indexes by nearly 200 basis points, indicating that quality is a meaningful component when it comes to evaluating small-caps. On that note, it’s worth acknowledging that quality and dividends often imply a company is profitable – something to consider when just 60% of the Russell 2000 is profitable.

OUSM Could Be Obvious Small-Caps Choice

The universe of small-cap ETFs is expansive, populated by hundreds of offerings, but OUSM could be a stand-out at a time when some market observers are encouraging investors to focus on quality as the avenue through which to revisit smaller stocks.

“We prefer quality SMID-cap stocks that focus on profitability and growing competitive advantages. Some SMID-cap companies carry high levels of debt and a valuation discount for these stocks seems reasonable. However, today’s near-record discount in the highest-quality SMID-cap stocks does not,” observed Sitara Sundar of J.P. Morgan Wealth Management.

Indeed, small-cap valuations are noticeably depressed. While OUSM isn’t a dedicated value fund, it does allocate nearly two-thirds of its roster to financial services, industrial, and consumer cyclical stocks, giving it something of a value feel. That’s potentially attractive because it’s possible the large/small valuation gap will come in over the near term.

“High-quality smaller-cap stocks now trade at a near-record valuation discount versus their large-cap peers, despite having similar cash flows and profit margins. We believe that gap will narrow, creating a potential entry point,” added Sundar.

Specific to OUSM, that sentiment is encouraging because it indicates investors don’t have to pay up to access the benefits of dividends, quality, and reduced volatility — factors that often command premium multiples.

VettaFi LLC (“VettaFi”) is the index provider for OUSM, for which it receives an index licensing fee. However, OUSM is not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of OUSM.

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