It’s not that smaller stocks are in the red this year. As measured by the S&P MidCap 400 and the S&P SmallCap 600 indexes, smaller equities are in the green. But they’re also being trounced by the large-cap S&P 500. The S&P 500 has been less turbulent than mid- and small-cap indexes. So it’s understandable why some investors steered clear of small stocks and funds this year. That has proven to be the proper course of action in 2023. But the landscape could change next year. That could potentially bring ETFs such as the VanEck Morningstar SMID Moat ETF (SMOT) into the limelight.
In what’s been a trying environment for smaller stocks, SMOT is performing admirably, posting a 6% year-to-date gain as of Nov. 24. To the ETF’s credit, it’s established some momentum in recent weeks, surging 9.35% for the month ending Nov. 24. That could be the foundation of more upside as 2024 looms.
Valuations Could Favor SMOT ETF
SMOT follows the Morningstar US Small-Mid Cap Moat Focus Index. As the name of that index implies, it is home to both small- and midcap stocks. These days, that could be an attractive mix, because valuations on smaller stocks are extremely depressed.
“To put this valuation opportunity into perspective, as of October 31, 2023, mid-caps were trading at 12.9 times earnings, well below their long-term 20-year average of 18.3 times,” noted Coulter Regal, VanEck product manager. “In contrast, large-caps were trading at 19.1 times earnings, well above their 20-year average of 17.5 times earnings. Based on those numbers, mid-caps are trading at nearly a 30% discount to their long-term average and an even greater relative discount to where large caps sit today. This presents a valuation opportunity not seen in over 20 years.”
The weight average market capitalization of SMOT holdings was $15.1 billion at the end of October, indicating the ETF tilts more toward larger midcap and smaller large-cap fare. For investors considering the ETF, that trait is relevant because it highlights midcap advantages as well as the utility of paring mid- and small-cap stocks together under one umbrella.
“Mid-cap stocks have delivered higher returns than large-cap stocks over the past two decades, a testament to their potential for business growth and scalability,” concluded Regal. “Concurrently, they have exhibited lower volatility than small-caps, reflecting a greater level of stability due to more developed business models. The inclusion of mid-cap stocks in an investment portfolio can be a strategic decision. When combined with small-caps, mid-caps can provide balance, enhancing the potential for return within a portfolio while simultaneously helping temper volatility.”
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