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The Importance of Active Management for Small Caps

The Importance of Active Management for Small Caps

New York - January 22, 2024 ~ Using actively managed ETFs in the small-cap sector is extremely important as 23.0% of the index loses money vs. only 2.0% in the S&P and 4.4% in the Dow.  Investing in profitable companies trading at reasonable multiples is the heart of good investing, as profitable companies typically retain a substantial portion of their earnings and invest the earnings in new high-return investments related to their existing business.  These investments provide for steady earnings growth and reliable stock price appreciation over the long term. 

Money-losing companies, conversely, often need to raise external capital to fund operating losses, which results in dilution to existing holders.  Also, earnings-negative companies are more likely than strongly profitable businesses to go bankrupt.  Finally, because of the uncertainty relative to the future profitability of money-losing companies, they tend to be more volatile than stable companies with profitable operations. 

The other element of small-cap stocks is that fewer companies pay dividends in the Russell 2000 at 44.4% vs. the S&P 500 at 76.7% and the DOW at 91.6%.  Within the Russell 2000, the average PE multiple of the dividend payers is only 20.4x while the non-dividend payers have an average multiple of over 27.4x.  The average 5-year earnings growth rate of the non-dividend payers is 12.9% but still 12.5% for the dividend payers.   Therefore, the PEG (Price/Earnings Growth Rate) ratio is substantially higher for the non-dividend payers.  It is important to not over-pay for growth by buying stocks with a PE/growth ratio that is too high as there is a high probability of underperforming the market whereas investing at reasonably priced stocks is more likely to match or exceed the market returns as a whole.

We continue to believe that the stock market will move significantly higher this year with the S&P up more than 15% as we have a 5,500 target based on 20.5x the 2025 S&P estimated 2025 earnings of 270.  We believe that both the stock and bond markets will be propelled higher by a wave of global rate cuts as inflation continues to moderate and growth drops in Europe and the rest of the world.  We also believe that small-cap stocks will outperform the market this year.   Utilizing active management potentially allows investors to tap into this attractive market in a lower-risk way by focusing on quality companies that pay substantial dividends.

Active Management Small Cap - IWN Earnings Buckets

Active Management for Small Caps - IWN, Money Ma

From Bloomberg as of 12/31/2023. This data was prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice. Investors cannot directly invest in an index and unmanaged index returns do not reflect any fees, expenses or sales charges. The comparative data is provided for information purposes only and should not be relied upon for making comparative investment decisions.




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