Cheaper Small Caps Mean The Right ETF Offers Income | ETF Trends

As has been widely discussed, small-cap stocks and the related ETFs have lagging large-cap equivalents over the past several months. This month, however, there are signs small-cap stocks are bouncing back.

Investors may want to access that still nascent resurgence in conservative fashion with the ProShares Russell 2000 Dividend Growers ETF (CBOE: SMDV), which is slightly outpacing the Russell 2000 Index to start September.

SMDV, a dividend spin on the Russell 2000, the benchmark U.S. small-cap index, tracks the Russell 2000 Dividend Growth Index, which includes small-cap firms with dividend increase streaks of at least a decade. The ProShares ETF is one of the highest-rated funds in the small-cap value category.

Interestingly, the recent decline in small caps has made the group attractive on valuation.

“The relative valuation of U.S. Small-cap stocks has been declining steadily for nearly 10 years. Small caps have gone from near parity on a price-to-book basis to a nearly 40% discount,” said ProShares in a recent note.

Reasons To Consider SMDV

SMDV offers investors a higher dividend yield than is found on basic small-cap benchmarks, such as the Russell 2000 Index. Additionally, dividend growth is a quality trait, which can help investors reduce some of the volatility associated with owning small companies. Data confirm that institutional investors are diving into small caps.

“There are two key elements for the bull case for small-cap stocks,” notes ProShares. “The first is valuation. As noted in the chart of the month, small-cap stocks now trade at nearly a 40% price-to-book discount to large-cap stocks. That compares to a long-term average discount of around 25%. That’s, of course, no guarantee that small caps are on the cusp of outperformance. That discount briefly surpassed 50% at the height of the mega-cap bubble in 2000, but it is a compelling data point.”

Related: Small Cap Dividend ETF Adds Some New Holdings 

Investors mulling small caps should also consider the Federal Reserve’s near-term plans for interest rates. The central bank meets later this month and is expected to lower rates by 25 basis points.

“The second element is the notion that small-cap stocks tend to be outsized beneficiaries of monetary policy easing and low interest rates. The theory goes as follows: Small-cap stocks have more leverage than large-cap stocks, so small caps benefit disproportionately from lower interest rates. The evidence is mixed,” according to ProShares.

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