In recent years, the stock market has been dominated by large companies, particularly tech giants known as the “Magnificent Seven.” The Russell 1000 index, which focuses on large-cap stocks, has seen a more than 14 percent increase in 2024 through the end of June, while the small-cap Russell 2000 index has only risen by less than 2 percent during the same period.
This disparity in performance has led to small-cap stocks trading at a significant discount compared to large-caps, presenting an opportunity for investors to consider undervalued investments.
Comparison of Small-cap vs. Large-cap Performance
Large-cap stocks, especially tech giants like Nvidia and Microsoft, have significantly outperformed small-cap stocks in recent years. This performance breakdown illustrates the trend:
| Russell 1000 | Russell 2000 | |
|---|---|---|
| Note: Performance through 6/28/2024 | ||
| YTD (through June 2024) | 14.2 percent | 1.7 percent |
| 1-year | 23.9 percent | 10.0 percent |
| 3-year | 8.7 percent | -2.6 percent |
| 5-year | 14.6 percent | 6.9 percent |
| 10-year | 12.5 percent | 7.0 percent |
Outlook for Small-cap Stocks
Small-cap stocks currently trade at a forward price-earnings ratio of approximately 14, compared to about 21 for large-cap stocks. This is the largest gap since the late 1990s tech bubble. Some investors believe that potential interest rate cuts by the Federal Reserve could benefit small-cap stocks, which are more sensitive to economic changes and external financing.
Francis Gannon, co-chief investment officer at Royce Investment Partners, anticipates a reversal in the dynamic later this year as small-cap profits recover. He notes, “Small-cap earnings over the past year were disappointing, declining more than 10 percent in 2023, while large-cap earnings were robustly positive.”
Small Caps in the AI Landscape
While large-cap stocks have reaped the benefits of AI investments, there are opportunities for small-cap companies to leverage the rise of artificial intelligence. David Sekera, chief U.S. market strategist at Morningstar, suggests shifting away from overvalued large-cap AI winners and exploring opportunities in small-cap and mid-cap stocks.
“As is often the case with new technologies, small-cap companies tend to proliferate in the background of the megatrend,” says Gannon. “Nonetheless, they will be meaningful players as they are providing — or will ultimately provide — many of the products and services supporting the buildout of a vast AI infrastructure.”
Adding Small-cap Stocks to Your Portfolio
If you are considering adding small-cap stocks to your portfolio, you can choose to invest in individual small-cap stocks or opt for an ETF that holds a diversified basket of small-cap stocks. Rebalancing or increasing your small-cap allocation may be advantageous given the potential for small-caps to outperform in the near future.
For a list of the best small-cap ETFs, check out Bankrate’s recommendations.
Editorial Disclaimer: All investors should conduct their own independent research into investment strategies before making any decisions. Past performance is not indicative of future results.