It’s a Small Cap World

Little? Big? Little? Big? Which one will perform better? We will find out.

US small-cap stocks have taken a bigger hit during the pandemic than large-cap stocks.

• The Russell 2000, an index representing 2,000 of the smallest stocks in the US, is down over 10% in 2020. In June, 42% of these companies were losing money or barely breaking even.

In past periods of economic distress, small caps typically outperform large caps. This time, history doesn’t repeat itself. COVID devastated small-cap businesses that sell mostly to the local economy.

Small-cap advantage

Small-cap stocks have one key advantage over their larger counterparts, cheaper valuations. The price/earnings (P/E) ratio of small-caps remain at 17.65 vs 23.86 for large-caps. The lower P/E ratio shows a discount amongst small caps. For your money’s worth, small caps are much cheaper than large caps but will enough investors see the value in these stocks to purchase and drive up their prices?

(TAJ: What is a P/E Ratio?)

Expert opinion

Leo Kelly, founder and president of Verdence Capital Advisors, sees value in small-cap value stocks which are still down over 20%. A push to bring manufacturing back in the US will benefit US-based industrial and financial companies, two sectors that make up a large portion of small-cap stock indexes.

Nick Ford, fund manager of Premier Milton Investors, thinks that US small caps are at attractive prices and will benefit from a US economic recovery more than large caps.

Prepare for a small-cap recovery with these ETFs

Small-cap stocks are more volatile and risky than large-cap stocks. It is often safer for everyday investors to buy an ETF that holds a basket of small-cap stocks than investing in individual small-cap stocks that experience large price swings.

• iShares Core S&P Small-Cap ETF ($IJR)… Holds a basket of 600 diversified small-cap stocks
• Vanguard Small-Cap Growth ETF ($VBK)… Holds a basket of 577 small-cap growth stocks
• Vanguard Small-Cap Value ETF ($VBR)… Holds a basket of 978 small-cap value stocks

(TAJ: What is the difference between value and growth stocks?)