Small-Cap ETF Valuations Look Frothy | ETF Trends

With the equities market pushing forward, some are beginning to grow cautious on small-capitalization stocks and related exchange traded funds that reveal frothier valuations, potentially capping further gains.

For example, the iShares Russell 2000 ETF (NYSEArca: IWM) has a 18.6 price-to-earnings ratio, iShares Core S&P Small-Cap ETF (NYSEArca: IJR) has a 18.7 P/E and Vanguard Small Cap ETF (NYSEArca: VB) has a 19.2 P/E. In contrast, the SPDR S&P 500 ETF (NYSEArca: SPY) shows a 17.3 P/E, according to Morningstar data.

Despite falling behind large-cap shares in 2014, fund managers and analysts are warning that small-cap stocks are trading at valuations above long-term averages, reports David Randall for Reuters.

Steven DeSanctis, an analyst at Bank of America Merrill Lynch, believes that Russell 2000 companies look expensive relatively to historical averages as the trailing price-to-earnings ratio of the Russell 2000 hovers around 22.7, or 40% more than its long-term average of 16.2.

“Small-cap companies have something of an advantage in this economy. But investors have figured that out,” Phil Orlando, chief equity strategist at Federated Investors, said in the Reuters article.

Due to the recent bounce in small-caps, DeSanctis argues that the high valuations could cut into returns.