Small Caps Are Trading at a Massive Discount to Large Caps

There are still deals in today's market.

Yes, despite the incredible run we've seen... with the overall market hitting new highs... and certain stocks jumping hundreds of percent... you can still find value opportunities right now.

In fact, you can find that in a large portion of the overall market. That's because small-cap stocks have been lagging their larger peers.

While the S&P 500 Index has hit new all-time highs, small caps have yet to fully recover from their March bottom.

Small caps are now trading at one of the largest discounts to large caps in decades. It likely won't stay that way for long, though.

Small caps could soar much higher to try and close the gap. That means big gains and big outperformance could be on the way.

Let me explain...

There are many ways you could look at a valuation gap between areas of the market. Today, we'll use the price-to-book (P/B) ratio.

This gives us a quick look at how much you're paying for a company's assets. The higher the P/B ratio, the more expensive the stock is. And a spread in P/B ratios between assets can highlight a valuation gap.

Today, small caps trade for a P/B ratio of just 2.0 based on the benchmark Russell 2000 Index. That's much cheaper than the S&P 500's P/B ratio of 3.8.

Even more, this is one of the largest gaps we've seen in recent years. Take a look...

The discount of small caps to the S&P 500 sits at 46% based on this measure. And the gap this year is larger than any we've seen since 2001.

Buying back then would have led to solid outperformance over large caps in the following years. From October 2002 through October 2007, the Russell 2000 rallied 161%. Meanwhile, the S&P 500 was up just 111%.

You'll probably notice that small caps have historically traded at a discount to the S&P 500. There isn't even a 0% line on the chart above, which means they've never been more expensive than large cap stocks over this date range.

That's fine though. Because the discount is usually much smaller than what we see today.

Since 1999, the average P/B discount has been around 27%. And from 2004 to 2013, there were several years when that discount was even less. So while we can continue to expect a discount, we shouldn't expect one this large to last long.

Small caps will likely break back out to new highs in the coming months. And they will likely begin outperforming larger stocks in the process, closing the valuation gap.

If you want to buy small caps, you can easily do so with the iShares Russell 2000 Fund (IWM). This simple fund tracks the Russell 2000 Index, the benchmark for small-cap stocks.

These stocks are incredibly cheap today compared to the overall market. But history tells us that this won't last. Expect a big move in these stocks in the coming months.

Good investing,

Chris Igou

Further Reading

"When it comes to extreme wealth creation, almost nothing can compare to being an owner of a small company that grows large," Matt McCall writes. And right now, a handful of small companies stand to soar as their innovations change the way we live... Read more here: This Investing Advantage Could Be the Secret to Massive Wealth.

When it comes to investing in small-cap stocks, massive gains don't happen overnight. You need to have a strategy if you want to be successful. That's why Matt explains the "coffee can" approach to making venture capital-like gains... Get the full story here: This 'Coffee Can' Trick Could Help You Get Rich in Stocks.

INSIDE TODAY'S
DailyWealth Premium

It's a rapidly growing cannabis company with triple-digit upside potential...

Small-cap stocks could outperform large caps thanks to today’s valuations. And this small cannabis company will likely be a big winner as this plays out in the market…

Click Here to Get Immediate Access

Market Notes

TO RETURN TO 'NORMAL,' THE WORLD NEEDS THIS LIFE SCIENCES GIANT

Today, we’re checking in on a major player in the global fight against COVID-19…

With businesses reopening, people returning to work, and kids heading back to school, we’re starting to see some semblance of “normal.” But even so, coronavirus cases continue to rise… and that means access to quick and accurate testing is more important than ever. That’s where this leading life sciences company comes in…

Thermo Fisher Scientific (TMO) is a top producer of laboratory hardware, supplies, and diagnostic test kits. During the pandemic, it has supplied coronavirus tests and tools to safely transport test samples. Recently, it has worked to expand its direct-to-patient services that deliver clinical trial medications directly to patients’ homes. Just last week, Thermo Fisher reported strong third-quarter earnings, with revenue reaching $8.52 billion… nearly a quarter of which came from COVID-19-related sales.

As today’s chart shows, TMO has rallied about 90% since bottoming in March, recently hitting a fresh all-time high. As demand remains strong for its testing products and instruments, Thermo Fisher should remain in an uptrend…

Click Here to Continue Reading
Recent Articles
This Investing Advantage Could Be the Secret to Massive Wealth

Knowing the difference between these two types of growth instantly sets you apart from your fellow investors. It gives you a huge advantage, which can make you millions of dollars over the coming years...

You Must Prep for the Melt Down Today

The final leg of the Melt Up is here. That means you've got to be on board the ride now. But just as important, it means you've got to be ready for the Melt Down...

A Melt Up Is Never a Smooth Run Higher

A Melt Up can mean life-changing gains in a matter of months. But while big gains are likely, I want to be very clear about what we should expect as we invest in today's environment...

Full-Blown Euphoria Is on the Way

As longtime readers know, Steve has popularized the term "Melt Up"... And the philosophy behind the Melt Up is simply that policymakers will push markets to ridiculous extremes just to keep things rolling in the "right" direction. It doesn't take a market wizard to realize this is playing out today...

A New Band of Traders Is Flooding Into the Market

Robinhood made its name by starting the trend of zero-fee trading. And this year, it has shepherded in a new band of investors... the kind of folks that can propel the Melt Up in stocks to incredible heights...

The Poster Child for This Stock Market Boom

When the virus hit, and professional sports shut down for months, it put sports bettors out of commission. The stock market was the perfect place for them to get their fix...

Biotech Is Outperforming... And This Is Just the Start

Despite this roller coaster of a year, this sector that has really been on fire in recent months shouldn't be surprising...

An Important Market Laggard Breaks Out

If you're having a hard time trusting this new bull market, don't beat yourself up. It's normal. Scars from a market crash don't go away quickly... But you can't let them control you forever...

The Investment Pros Are Finally Getting Bullish

For the first time since the massive stock rally began back in March, the investment pros are suddenly interested. And that could help drive the next leg of the rally...

View Full Archive