The benefits of wide moat investing are not a large-cap-only phenomenon. At a time when some market observers are forecasting that mid- and small-cap stocks are poised to get their respective acts in gear and potentially break the stranglehold of the “magnificent seven” on broader market returns, investors may want to consider the potency of the wide moat/smaller stocks combination.
An efficient avenue for accessing that combination while eschewing stock picking is the VanEck Morningstar SMID Moat ETF (CBOE: SMOT). SMOT, which follows the Morningstar® US Small-Mid Cap Moat Focus Index, is higher by 9.05% year-to-date. That’s better than the average return of nearly 5.5% posted by the S&P MidCap 400 and the S&P SmallCap 600 indexes.
Alone, SMOT’s year-to-date showing is impressive, particularly when measured against broader small stock gauges. However, the exchange traded fund’s 2023 sturdiness is all the more notable when accounting for the fact that, until recently, smaller equities have been under duress owing to market participants’ recession fears.
History, Valuation on SMOT’s Side
Regardless of market capitalization, wide moat stocks are shares of companies with deep competitive advantages. As such, it’s reasonable to expect that investors might pay up for such an enviable trait. However, SMOT’s underlying index scours the relevant equity universe for wide moat names trading at attractive multiples. Fortunately, that landscape is somewhat expansive today.
“However, taking a closer look, we find that the current valuation of these smaller-cap stocks is becoming increasingly attractive relative to large-caps,” noted Coulter Regal, associate product manager at VanEck. “This combined with an economic recovery phase possibly on the horizon, where smaller-caps have historically outperformed, supports the case that now may be a good opportunity for investors to allocate to this area of the market.”
One reason that mid- and small-cap stocks, including some SMOT holdings, are currently trading at attractive multiples is that while the U.S. economy isn’t officially in a recession, smaller stocks have been punished as if economic contraction is the current state of affairs.
That’s not the case, and the market’s recent treatment of smaller stocks has arguably been too harsh. On the other hand, there’s potentially good news for SMOT: the precedent of smaller stocks to perform well coming out of recessions.
“While small- and mid-cap stocks often bear the brunt of a recession, they also tend to bounce back strongly during the recovery phase. Historically, smaller companies have outperformed their larger counterparts 83% of the time in recoveries and saw average annualized returns of 26% during the recovery phase,” concluded Regal.
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