Dow vs. Small Caps: Which Is the Better Value? – Giant Interactive Group Inc (ADR) (GA), The Men’s Wearhouse, Inc. (MW), Ingles Markets, Incorporated (IMKTA)

Page 1 of 2

All week, we’ve been celebrating brand-new record highs for the Dow Jones Industrials . The average finally managed to overcome its October 2007 levels on the back of strong economic data and investors’ willingness to downplay potential bad news and remain optimistic about the future of the global economy.

But another part of the market has been setting new all-time highs repeatedly for nearly two years. Small-cap stocks have outpaced their larger counterparts with even bigger gains lately, and that has some investors wondering whether large-cap stocks like those in the Dow, even at record highs, are still the best value in the market.

Giant Interactive Group Inc (ADR) (NYSE:GA)Sending valuations through the roof
Small-cap stocks have a reputation for leading the stock market out of recessions, and that tendency has played out perfectly in the bull market of the past four years. When you compare the Russell 2000 Index to its Russell large-cap counterpart, you’ll see that the small-cap index quickly jumped into the lead after the March 2009 lows and then expanded on its gains with a 10-percentage-point return advantage in 2010. By April 2011, the index had already regained all its lost ground and set new highs, and after a pullback, the Russell 2000 hit another new high in September 2012 and has continued higher, setting new records throughout the new year.

As a result of these moves, earnings-based valuations for the Russell 2000 are extremely high compared to those of their large-cap counterparts. As of March 1, the Russell’s trailing P/E was more than 32, as opposed to less than 18 for the S&P 500 and less than 16 for the Dow. Those figures suggest that large-cap stocks are a much better value.

Interestingly, though, even though the small-cap index has risen over the past year, the Russell’s P/E has actually fallen dramatically, having been above 42 in March 2012. By contrast, trailing earnings multiples have climbed for both the S&P and the Dow.

Arguably, a more equitable comparison looks at forward earnings projections. There, the disparities are much less extreme, with the Russell trading at about 16 times forward earnings. That’s higher than the corresponding Dow multiple of 12.5 and the S&P’s 13.7 — but by a much more manageable margin. Given the higher average growth potential that small-cap stocks have compared to large-caps, it’s easy to justify a premium as slight as the current one.

Will small caps lose out to the Dow?
Large caps and small caps often perform in cycles. For a while, small-cap stocks outperform as they prove more nimble and able to navigate changing economic trends than their larger counterparts. Eventually, though, big companies catch up and are able to use their size advantage to outpace their tiny competition.

If you invest purely by asset allocation without doing any individual stock-picking, then deciding whether small caps or the Dow offer a better value right now depends on your view of the macroeconomic environment. If you think the expansion has further to run, then small caps will likely do a better job finding the next lucrative niche profit opportunities. But if you think the recovery has run its course, then large caps are in a better position to survive a round of tough times, with good cash levels on their balance sheets.

Page 1 of 2
blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

The 34 Smartest Countries in the World

The 10 Countries with the Highest Suicide Rates

The 10 Most Technologically Advanced Countries in the World

The 10 Safest Countries in the World to Live in Peace

The 10 Top Selling Smartphones in the World 2014

The 12 Biggest Shopping Centers in the World

The 10 Friendliest Countries in the World

Qihoo 360 Technology Co Ltd (QIHU), Actavis plc (ACT), Yahoo! Inc. (YHOO) Among 20 Long Ideas from Sohn Canada

The 10 Laziest Countries in the World

The 10 Most Polluted Countries in the World

The 10 Most Dangerous Cities in America 2014

The Top 10 Gold Producing Countries in the World

The 10 Tallest Buildings in the World

The 10 Richest Stand Up Comedians in the World

The 10 Fattest Countries in the World

The 5 Best Summer Jobs for Teens

The 10 Most Religious Countries in the World Keeping the Faith

The 10 Most Educated Countries in the World

The 10 Most Popular Cell Phones in the World

The 10 Drunkest Countries in the World

The 10 Most Expensive Private Schools in the World

The 10 Smallest Countries in the World

Walking Dead Season 5 Spoilers You’ll Wish You Didn’t Know

The 10 Poorest Countries in the World

The 10 Greenest Countries in the World

The Top 10 Countries with the Highest Population in the World

The 10 Most Visited Countries in the World

The Top 10 Star Wars Characters in the Iconic Series

The 10 Most Expensive Android Phones in the World

5 Reasons Why The Illuminati Is Real and a Threat to Society

The 6 Scariest Halloween Costumes Ever Screamed At

The 4 Biggest Hedge Fund Managers in the World Today

The 15 Most Densely Populated Countries in the World

The 10 Biggest Tea Drinking Countries in the World

Top 6 Ways to Improve Your Checkout Process and Close Sales

The 5 Most Profitable Online Businesses You Can Start Today

The 20 Most Profitable Hospitals in the US

The 5 Most Profitable Home Businesses to Start

The 7 Teams that Will Win the Stanley Cup in 2015

The Top 10 Most Expensive Digital Cameras to Snap Stunning Shots With

The 10 Highest Quality Fast Food Restaurants In America Today

The 8 Best Halloween Decorating Ideas to Spook Up Your House

10 Marvel Women that Should Get a Movie Right Now

The 20 Best Remixes of Popular Songs that Will Make You Forget the Originals

7 Most Expensive Cities in the World

5 Least Expensive Cities in the World

10 Celebrities Who Believe In Scientology

10 High Margin Food Products to Build a Business Around

The 10 Most Expensive Clothing Stores in the United States to Get Decked Out At

The 5 Biggest Kickstarter Scams That Swindled Backers’ Donations

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!