FYI: Copy & Paste 4/4/14: Joe Light WSJ
Regards,
Ted
There is expensive and then there is exorbitant.
Small-company stocks increasingly look like the latter.
Consider: The S&P 500 index of large-company stocks is up 176% since its low on March 9, 2009. Over the same period, the Russell 2000 index of small-company stocks is up 236%.
On some measures of value, small-cap stocks—which are often used to juice a portfolio—look pricier than they ever have been. With that in mind, investors should consider cutting their holdings of small companies and favor the least speculative parts of the market, some experts say.
"No matter how you slice the data, small caps look expensive," says Steven DeSanctis, a small-cap strategist at Bank of America Merrill Lynch
Investors expect bigger returns on small-company stocks, typically those with a market capitalization of $5 billion or less, than their larger peers. That is because small companies have uncertain earnings and revenues, making them riskier.
But historically that small-cap premium has been relatively tiny, and some researchers argue that it doesn't even exist, says William Bernstein, co-principal of investment-advisory firm Efficient Frontier Advisors in Eastford, Conn.
Mr. Bernstein says that he doesn't think small-company stocks are pricey enough to warrant making big shifts in a portfolio. But by some measures, small U.S. companies look increasingly rich.
There are lots of ways to determine if a stock is overpriced.
For small caps, Doug Ramsey, chief investment officer at investment-research and asset-management firm Leuthold Group, likes to look at the stock price divided by an average of five years of earnings, which he says historically has been the most useful in picking times to buy and sell.
By that method, the median small-company stock has a price/earnings ratio of 28.4, well above the historic median of 21.4, according to Leuthold. That also is a much steeper price tag than that of large-company stocks, which have a P/E of 21, nearly the same as they have had historically. The 34% premium for buying small caps over large caps also is well above the mere 2% median premium they have had since 1986.
Some investors prefer measuring the stock price against sales, since small companies may not have profits. By that method, such stocks look even more overpriced. At the end of February, the latest data available, the Russell 2000's price/sales ratio was about 1.6, the highest it ever has been, according to Mr. DeSanctis, whose data go back to 1979.
For long-term investors who aren't convinced small caps are overpriced and prefer not to sell outright, an option might be to rebalance their portfolios ahead of their normal timetable.
Small-cap stock prices would have to rise another 7%, assuming five-year earnings stayed constant, to reach the height of expensiveness they attained during the dot-com bubble.
But more-active investors, such as Mr. DeSanctis and Mr. Ramsey, advise that investors start scaling back their small-cap exposure sharply now.
One good reason: Toward the tail end of bull markets, large-cap stocks tend to lead small caps, Mr. Ramsey says. At more than 60 months, the current bull market already is longer than the one that ended with the financial crisis in October 2007.
Small-cap stocks make up between 7% and 10% of a typical U.S. total-stock-market mutual fund or exchange-traded fund. For their own portfolio, investors would be well-served to cut that in half to 3.5% to 5%, Mr. Ramsey says.
The balance can go to parts of the market that look cheaper. Right now, that means going abroad, Mr. Ramsey notes. The cheapest options include the Vanguard Total International Stock VXUS -0.23% ETF, which charges annual fees of 0.14%, or $14 per $10,000 invested, while the iShares Core MSCI Total International Stock IXUS -0.24% ETF, which costs 0.16%.
To the extent that an investor keeps a small slug of small caps, he should tilt toward high-quality companies with earnings and away from companies not making a profit, Mr. DeSanctis says. That means being wary of biotechnology and pharmaceutical companies, many of which aren't profitable.
And in choosing between overpriced stocks or overpriced bonds, don't forget cash. It won't give a positive return, but could come in handy once a drop in stocks inevitably arrives.
Russell 2000 Index:
http://www.russell.com/indexes/americas/indexes/fact-sheet.page?ic=US2000S&P 600 Index:
http://www.spindices.com/indices/equity/sp-600 .
Comments
Old_Skeet