If 2023 was the year of the mega cap tech stock, 2024 may see SMIDcap stocks rise to new prominence. While key names in the “Magnificent Seven” remain big players, strategies that look for SMIDcap opportunities could appeal. Valuations are such that investors may want to consider new approaches.
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That was the main focus of discussion during the second segment of VettaFi’s Equity Symposium on Wednesday, March 13. In a discussion titled “Valuation Matters: Know What You Own,” T. Rowe Price’s Lead Portfolio Manager Jodi Love and VanEck’s ETF Product Manager Coulter Regal discussed their respective shops’ views on valuations and opportunities.
Hosted by VettaFi Vice Chairman Tom Lydon, the pair discussed their firms’ approaches and their related ETFs. If 2023’s story focused on the Magnificent Seven, then what lies ahead in 2024? For Love, opportunities elsewhere in the market appeal.
“I think the rest of the market should not be ignored this year,” she said. “We do strongly believe that small and mid-cap stocks are really attractively valued right now. Small-cap S&P 600 is trading at 14 times versus the 20-year average of 16.5 times, so just over a 15% discount.”
VanEck’s Regal also sees opportunity in smaller firms, as the Magnificent Seven started 2024 with some divergence.
“We’ve seen a couple of those leaders kind of pull back a little bit,” he said. I think this divergence that we’ve started to see might be signs of cracks, potentially, and bode well for things like value stocks and small midcaps.”
So, how do both firms look to play valuations and SMIDcap stocks’ appeal? VanEck works with Morningstar on their MOAT strategies, leaning on that firm’s “forward-looking, analyst-powered assessment of a company’s valuation.”
“They essentially project a company’s profitability and earnings potential, 20-plus years into the future and discount that back,” Regal explained. “They’ll arrive at an estimate of what the fair value of the stock they believe should be today.”
Per Love, T. Rowe Price leans on its own research prowess. The firm’s active managers and researchers consider a “blend” of valuation metrics.
“We really do lean in the small-cap space, though, to quality and profitability,” she said, pointing out the negative earners in the SMIDcap stocks space.
“Ultimately, we value companies with really good growth prospects that have a pathway to profitability even if they’re not profitable now,” Love added. “So our key metrics — P/E, obviously free cash flow yield — which we think is very important for small-caps, given some of them have very high leverage.”
SMIDcap Stocks and ETFs
T. Rowe Price’s active approach could exploit a potential soft landing scenario and Fed rate cuts. Should rate cuts kick-start SMIDcap stocks, an ETF like the T. Rowe Price Small-Mid Cap ETF (TMSL) may appeal.
“We employ a fundamental and active bottom-up stock selection process… [that]allows us to be flexible and to really lean into stocks where we feel we can generate the most alpha,” she added.
TMSL charges only 55 basis points (bps) to take that research-driven fully active approach and has returned 15% over the last three months, per VettaFi data.
VanEck, meanwhile, offers its MOAT strategies, the VanEck Morningstar Wide Moat ETF (MOAT) and the VanEck Morningstar SMID Moat ETF (SMOT). Both track indexes and operate with the aforementioned Morningstar-boosted analyses.
“The MOAT investing philosophy is all about identifying those quality companies that possess sustainable competitive advantages,” Regal said. “Valuations is the second part of that, and very important … ensuring you don’t overpay for those companies. That’s where we lean on Morningstar as well.”
MOAT charges 46 bps for its multicap approach, which has returned 15.3% over the last five years. SMOT, meanwhile, offers a similar emphasis on firms with competitive advantages, but in the SMIDcap stocks world, charging 49 bps.
T. Rowe Price and VanEck take different approaches, but both remain on the lookout for opportunities outside of large-caps. Those approaches may appeal to curious investors if 2024’s story diverge from 2023’s mega cap narrative.
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