Are Large-Cap Growth Stocks Overvalued Compared to Small-Cap Value Stocks?
The financial market is abuzz with speculation about the potential reversal of the significant outperformance of large-cap growth stocks over small-cap value stocks. A graph circulating on social media shows the price ratio of these two types of stocks, currently over two standard deviations above its 30-year average. But is this a fair assessment of their value?
To understand this, let’s compare large-cap growth stocks to small-cap value stocks using the analogy of orange juice and coffee. Just as the prices of these drinks can fluctuate based on individual supply and demand curves, so too can the prices of different types of stocks. The performance of these stocks is influenced by the sectors in which they operate and their earnings growth potential.
For example, the iShares S&P 500 Large Cap Growth ETF (IVW) includes tech giants like Microsoft, Apple, and Amazon, with a combined market cap of $13 trillion. In contrast, the iShares S&P 600 Small Cap 600 Value ETF (IJS) contains smaller companies like Robert Half and Comerica, with a combined market cap of $31 billion.
The sector breakdown of these ETFs further highlights the differences between large-cap growth and small-cap value stocks. Technology stocks dominate IVW, while financials are more prominent in IJS. These sectors have varying earnings growth profiles, with tech companies typically showing higher growth rates.
Earnings growth is a crucial factor in determining the fair value of stocks. Companies with higher earnings growth tend to have higher stock prices, as evidenced by a scatter plot of S&P 500 price returns and EPS growth rates. Analyzing the cumulative income growth of individual stocks like Microsoft and Robert Half can provide a more realistic perspective on their price ratios.
In conclusion, the comparison of large-cap growth stocks to small-cap value stocks should not be based solely on prices. Factors like earnings growth, sector composition, and buybacks play a crucial role in determining the fair value of these stocks. As investors, understanding these factors can help us make informed decisions about our portfolios and financial futures. Title: Unveiling the Top Investment Opportunity in Today’s Financial Market
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