Over a long period of time, many studies have come to a similar conclusion: Small-cap stocks, screened in some manner for reasonable valuation, have been very strong performers.
What Does Small-Cap Value Mean?
“Value” is a term that is used in different ways in the financial industry. First of all, how do you define “value”? Low price-to-earnings (P/E) ratio? Low price-to-book value ratio? A low price relative to a mix of different fundamentals? Not to mention how the allocation should be divided among different-value stocks—should the company with the most “value” get the most weight or should the biggest company by market capitalization?1
The S&P SmallCap 600 Value Index focuses on selecting stocks with low prices relative to three metrics: book value, earnings and sales. It’s notable that, as of December 31, 2016, there were 181 stocks included in this index that were also included within the S&P SmallCap 600 Growth Index. This happens because, although approximately one-third of the S&P SmallCap 600 Index universe is clearly value and one-third is clearly growth, there is a segment in the middle where weights of stocks are split between value and growth.
On the other hand, while the S&P SmallCap 600 Pure Value Index focuses on stocks with low prices relative to the same fundamentals, there is 0% overlap with the S&P SmallCap 600 Pure Growth Index. Instead of weight being proportional to market capitalization, another interesting element is that constituents are weighted in accordance with their attractiveness. In other words, lower prices relative to the defined fundamentals receive higher weights.
What Is WisdomTree’s SmallCap Earnings Approach?
Instead of directly placing the word “value” in the name of the Index or indicating that the concept of value is the primary focus, WisdomTree instead focuses on earnings. Within U.S. small caps, this leads to the following:
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