Following last month’s selloff, the Russell 2000 forward P/E declined from 15.8x to 14.5x, below its average of 15.2x and “back to historically cheap,” highlighted analysts at BofA in a note to clients.
Around 5% below their long-time average, small caps are set to outperform over the next 10 years, according to BofA. The relative PE of small vs. large caps stands at 0.73x versus the long-term average of 1x, and multiples imply 10% annualized returns for the Russell 2000 versus 3% for the Russell 1000.
Earnings have also been improving, with 90% of small and mid caps having already reported Q1 earnings. These have come in 5% better than consensus estimates, even though for small caps, earnings were still down 20% y/y. However, signs of a manufacturing recovery are supportive and there are more instances of guidance above consensus than below.
Within SMID, BofA favors value over growth, and recommends focusing on PE over PEG. Additionally, analysts at BofA said cyclical sectors rank better than defensive in BofA’s small-cap quant framework, with Industrials and Energy the top two ranking sectors.
“Both have seen improvements in BofA sentiment…these sectors also have less refinancing risk than most other small cap sectors,” the analysts added.