The Investing Sweet Spot? Straddle Small- and Mid-Caps with 'PDN'

International small- and mid-cap stocks (SMID) are often overlooked, but this asset class offers plenty of potential. Investors can get in on the action with the Invesco FTSE RAFI Developed Markets ex-U.S. Small-Mid ETF (NYSEARCA: PDN).

PDN is based on the FTSE RAFI Developed ex U.S. Mid-Small 1500 Index, which is comprised of small- and mid-capitalization equities of companies in developed international markets (excluding the US), selected based on four fundamental measures of firm size, including book value, cash flow, sales, and dividends. The equities are based on their fundamental strength and are weighted according to their fundamental scores.

U.S. small- and mid-caps have it easier than their international peers. Smaller U.S. companies benefit from operating in one of the easiest countries for commerce. The United States regularly places near the top in the World Bank’s annual rankings of countries for its ease of doing business. The companies have access to a population of 330 million consumers who principally speak one language, and they operate one set of national laws and regulations.

Easier doesn’t always mean better, or less crowded. There are avenues for growth with PDN.

“Higher quality at a lower price is not a combination that’s easy to find. And yet, by almost all measures, international SMID companies are higher quality than US small- and mid-caps, yet they have been trading on average at a 50% discount to them,” according to Invesco research.

PDN 1 Year Performance

PDN: A Powerful Play

On measures such as return on equity measures, international SMID companies are higher quality. They have been trading on average at a 40% discount to US small- and mid-caps. Yet investors have not taken advantage of this opportunity.

Underscoring the case for PDN are high quality traits and attractive valuations on international SMIDs.

“When it comes to valuations — as indicated by the trailing 12-month price/earnings ratios — these higher-quality international SMID companies have been available at just 50% of the price — (24.5 versus 48.0 trailing P/E ratios) — as of Dec. 31, 2020. That’s a 50% discount for higher quality,” adds Invesco.

PDN turns 14 years old in September and has nearly $385 million in assets under management. The industrial and consumer cyclical sectors combine for over 39% of the fund’s weight.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.