Small doesn't mean weak — in fact, small-company stocks are having their day in the sun — with small-cap blend funds up 15% so far in 2021, topping the returns of 4% for large-cap funds and 9% for midcaps, observes Rich Moroney, editor of Dow Theory Forecasts.
The million-dollar question: Can small-caps continue to march higher? Small companies are the most leveraged to a U.S. economic rebound.
Compared to large-caps, small stocks offer superior growth and reasonable valuations that could keep the party going. For 2021, median per-share profit growth is estimated at 13% for members of the S&P SmallCap 600 Index, versus 11% for stocks in the large-company S&P 500 Index.
Even with a 74% gain for the S&P 600 over the past 12 months, the median stock in the S&P 600 trades at 20.8 times trailing earnings, versus 22.3 for the median S&P 500 stock, or a 7% discount. Since 1994, small stocks have traded at an average premium of 1%.
Today, the smallest U.S. stocks look especially cheap. In our research universe, the median profitable microcap stock has a trailing P/E ratio of only 13.7, versus the norm of 15.4 since 1994.
Yet microcaps have generated eye-popping returns — the Russell Microcap Index has surged 95% over the past year. We generally view microcaps as those stocks with market values below $1 billion.
The 12 standout funds in the nearby table, including three microcaps, boast an average fund score of 88 and earn solid Morningstar ratings. Manager tenure for the funds averages nine years, and all 12 have reasonable expense ratios.
Consider First Trust Dow Jones Select MicroCap (FDM) a top pick. The exchange-traded fund mimics an index designed by Horizon Investment Services, a sister company of Horizon Publishing. Horizon Investment Services is compensated for creating the index.
The fund holds 152 stocks, with the largest valued at $2.9 billion and smallest at $33 million. Financials represent 32% of the portfolio. Up 26% so far this year, the ETF has a five-year annualized return of 15%. The expense ratio is 0.60%.
