The sheer abundance of beaten-down and bargain-priced small-company stocks suggests that now might be a good time to add a small-cap fund or two to a diversified portfolio, suggests Rich Moroney, editor of Dow Theory Forecasts.
Small stocks have seldom been so cheap. Consider the following points:
➤The median stock in the S&P SmallCap 600 Index trades at just 12.4 times trailing earnings - well below the norm of 18.3 since 1994, and lower than all but 2% of month-ends since 1994. Our figures exclude P/E ratios above 75 and below 0.
➤Roughly 34% of stocks (204 names) in the S&P 600 have trailing P/Es below 10, compared to 18% (108) a year ago and nearly four times more than the long-term norm of only 9% (54).
➤Based on Quadrix Value scores, which use P/E, price/sales, and price/ cash-flow ratios, as well as other key valuation metrics, the median S&P 600 stock earns a 62 - higher than 95% of month-ends since 1994.
➤ The average stock in the S&P 600 Index is down 20.5% so far in 2022, with more than one-third of index members down at least 30%. Nearly 70% of stocks have retreated more than 10% this year.
Of course, just because small stocks look undervalued doesn't preclude them from becoming cheaper. But mean reversion is a potent force. Over time, valuations typically revert toward long-term norms.
Two Dow Theory Forecasts recommended funds are reviewed below:
iShares Core S&P Small-Cap (IJR) tracks the broad S&P 600 Index, offering exposure to growth and value stocks. The portfolio is tilted toward financials (19% of assets) and industrials (16%). Sporting a tiny 0.06% expense ratio, the exchange-traded fund is down 20.9% so far in 2022. But the 10-year annualized return is 10.5%, ranking it among the top 6% of its peers.
Vanguard Explorer (VEXPX) focuses on small- and mid-cap growth stocks using quantitative and fundamental screens. Technology and health care each represent about 20% of the portfolio, which holds nearly 770 stocks. Explorer has ranked among the top third of its category in three of the last five years. The fund's expense ratio is 0.40%, and it earns a fund score of 97.