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Are US Large-Cap Stocks or US Small-Cap Stocks a Better Buy?

Nov 30, 2018

 

  • Today, we compare cumulative returns and next-twelve-month price/earnings multiples (NTM P/E) of US small-cap stocks, as represented by the Russell 2000 Index, against US large-cap stocks, as represented by the S&P 500 Index, in 2018 to understand which of the two may be a better value ahead of 2019.  
     
  • US large-cap stocks have outperformed US small-cap stocks in 2018 with the S&P 500 Index returning 1.56% YTD and the Russell 2000 Index falling 1.59% YTD.
     
  • As can be seen in the chart below, US small-cap stocks outperformed US large-cap stocks until the Russell 2000 Index observed a sharp 14.62% decline that began on September 20th and ended on October 24th. Over this period, US large-cap stocks offered slightly more stability, falling 9.37%.
     
  • Much of US small-cap stocks’ underperformance can be attributed to operating margins, which lag those of US large-cap stocks. As can be seen in the table below, the aggregate operating margin of the Russell 2000 Index is just 5.1% while the S&P 500 Index’s aggregate operating margin is a much more attractive 13.4%. Further, the Russell 2000 Index’s net profit margin of 2.9% is notably lower than the S&P 500 Index’s 13.4%.  
     
  • Forward earnings multiples for both US small-cap and US large-cap stocks have trailed off through 2018 as deaccelerating growth concerns are among the most prominent investor concerns.
     
  • The Russell 2000 Index is trading near its lowest premium to the S&P 500 Index in 2018 as one share of the Russell 2000 Index is 33.69% more expensive than one share of the S&P 500 Index, as of yesterday's close.  
     
  • The inexpensive premium on the Russell 2000 Index compared to the S&P 500 Index may represent a strong buying opportunity. As can be seen in the table below, constituents of the Russell 2000 Index offer a 427.7% high upside on a 12-month EPS growth estimate basis compared to the S&P 500 Index as analysts expect stocks in the Russell 2000 Index to grow at a rate of 102.9% in the next fiscal year while forecasting a growth rate of just 19.5% in the next fiscal year for stocks in the S&P 500 Index.  
     
  • 3-year EPS compound annual growth rate estimates reinforce the inexpensive premium for stocks in the Russell 2000 Index, as they are expected to grow at a compound growth rate of 36.2% over the next three years while stocks in the S&P 500 Index are expected to grow at a compound growth rate of just 10.4% over the next three years. Compared to the S&P 500 Index, analyst forecasts indicate that the Russell 2000 Index is a better buy.

 

Source: Capital IQ and Bloomberg

Source: Bloomberg
Index Name Fwd 12M P/E Ratio Trailing 12M P/E Ratio T12M FCF Yield FWD 12M EPS Growth (%) 3 Year Fwd EPS CAGR
S&P 500 Index 15.70x 18.77x 4.46% 19.54% 10.41%
Russell 2000 Index 20.98x 42.57x -0.06% 102.87% 36.18%
Source: Bloomberg
Index Name T12M ROE T12M Operating Margin T12M Net Profit Margin T12M Sales / Assets Assets / Equity T12M EBIT/EV
S&P 500 Index 15.97% 13.38% 10.11% 33.29% 4.46x 5.64%
Russell 2000 Index 5.08% 5.15% 2.88% 45.51% 3.91x 3.04%