US small-cap stocks have delivered strong returns in recent years. But value stocks have lagged the broader market. A closer look at what’s driving returns reveals some risks that deserve attention.
Since mid-2013, the S&P SmallCap 600 Index surged by an annualized 14.3%, outperforming larger-cap stocks. Yet small-cap value stocks, represented by the Russell 2000 Value Index, rose 11.0% per year.
What’s been driving performance? In the broader S&P 600, healthcare stocks accounted for more than a fifth of the market’s returns. That’s because the sector has done exceptionally well—and it comprises 12% of the index. Healthcare stocks are a much smaller component of the value index, and contributed much less to its returns.
The S&P 600’s heavy healthcare weight is risky, in our view. If the sector’s stellar performance reverses, investors could be in for a shock. What’s more, valuations are complex beneath the surface. The two indices trade at similar price/forward earnings ratios, yet the value index trades at a big discount on price/book and price/cash-flow ratios, which are important gauges of good value.
When investing in small-cap stocks, strong historical performance may obscure real future risks. Focus on companies across sectors with attractive valuations and strong fundamentals to get balanced exposure to smaller stocks with unrecognized recovery potential.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.