13 C
New York
Monday, March 4, 2024

IWM ETF: Time to Buy Small-Cap Stocks?

IWM ETF: Time to Buy Small-Cap Stocks?

If you’re looking to diversify away from 2023’s winners and invest in stocks that have lagged the rally but have the potential to catch up, the iShares Russell 2000 ETF (NYSEARCA:IWM) is an interesting option to consider. Small-cap stocks have lagged the broad-market rally, and IWM allows you to invest in nearly 2,000 of them. I’m bullish on IWM based on its catch-up potential and the discounted valuation that its holdings trade at. Plus, IWM could outperform coming out of a recession, as we’ll see below.

What is the Russell 2000?

Before jumping into the details of the ETF, let’s take a look at what the Russell 2000 index is. While the widely-known S&P 500 (SPX) is an index of 500 of the U.S.’s largest companies, and the Russell 1000 is composed of the 1,000 largest companies in the Russell 3,000 Index (an index that looks to benchmark the entire U.S. stock market), the Russell 2,000 is composed of the remaining 2,000 smaller companies on this list. The Russell 2000 is the most popular and widely-quoted index for small-cap stocks.

There’s no formal definition for what a small-cap stock is or a certain market cap that it must be under, but to get an idea, the largest holdings in IWM have market caps in the range of $6-$7 billion, with the exception of top holding SuperMicro Computer (NASDAQ:SMCI), which is an outlier with a $15 billion market cap, thanks to a gain of over 444% over the past year.  

The Setup 

Some investors are concerned that the market’s largest stocks have accounted for a disproportionate percentage of the overall market’s gains this year. The S&P 500 is up 14.5% year-to-date, and the tech-centric Nasdaq (NDX) is up 30.7%. The mega-cap tech stocks that dominate these indices are up even more. For example, Nvidia (NASDAQ:NVDA) is up 215.2% year-to-date, Meta Platforms (NASDAQ:META) is up 166.8%, and Tesla (NASDAQ:TSLA) is up 106.5%.

Because of these massive year-to-date gains, some investors feel the rally in these mega-cap tech stocks could be overdone and are looking for investment opportunities in stocks that haven’t yet joined in on the rally.

This makes the Russell 2000 an interesting place to look. Roughly flat year-to-date, IWM has underperformed both the Russell 1000 ETFs and S&P 500 ETFs like the iShares Russell 1000 ETF (NYSEARCA:IWB) and the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) by nearly 15% year-to-date. IWM also has underperformed Nasdaq-focused ETFs like the Invesco QQQ Trust (NASDAQ:QQQ) by nearly 40%. Given this setup, IWM could be ripe for a catchup rally. 

Favorable Valuation

Furthermore, while some observers are concerned about rich valuations among the market leaders, the small-cap stocks in IWM collectively trade at a cheap valuation. The average price-to-earnings multiple for IWM is just 10.4. This is just half of the valuation of the Russell 1000 index; IWB trades at a price-to-earnings multiple of 21.4. The S&P 500 and Nasdaq 100 both sport slightly higher price-to-earnings multiples, meaning that IWM is a bargain, no matter which index you compare it to. 

Additionally, if a recession is in the cards, as some economists believe, IWM might not be a bad place to park some money. Not only is it more defensive, with its lower valuation and lower year-to-date gains, but it could have considerably more torque as the economy rebounds out of a recession. The Wall Street Journal recently reported that in the 12 months after a recession is declared, small-cap stocks have beaten large-caps 11 out of the last 12 times by an average of 16.5 percentage points.    

Tremendous Diversification 

IWM provides investors with incredible diversification. Not only does it own 1,982 stocks, but its top 10 holdings make up a microscopic 3.45% of assets, taking concentration risk completely off the table. 

This makes IWM much more diversified than S&P 500 or Russell 1000 ETFs. For example, SPY owns 505 stocks, and its top 10 holdings, dominated by the big tech stocks, account for 31.5% of the fund. Meanwhile, IWB owns 1,011 stocks, and its top 10 holdings make up 28.9% of the fund. 

Below, you’ll find an overview of IWM’s top 10 holdings from TipRanks’ Holdings tool.

While these are smaller stocks, this doesn’t mean that they are beyond the purview of TipRanks’ Smart Score system. In fact, the Smart Score likes what it sees here. No less than seven of IWM’s top 10 holdings feature Smart Scores of 8 or above. The Smart Score is a proprietary quantitative stock scoring system created by TipRanks. It gives stocks and ETFs a score from 1 to 10 based on eight market key factors. A score of 8 or above is equivalent to an Outperform rating. 

Oilfield services provider Weatherford International (NASDAQ:WFRD) and oil and natural gas producer Matador Resources (NYSE:MTDR) lead the way with ‘Perfect 10’ Smart Scores.

But IWM isn’t limited to investing in the oil patch. It is well-diversified across sectors. Industrials have the largest weighting (17.4%) in the fund, followed by financials (16.4%), health care (14.1%), information technology (13.6%), and consumer discretionary (10.5%). In fact, while quite a few of IWM’s top holdings hail from the energy sector, energy has a weighting of just 8.5%. 

All told, there’s a lot to like about IWM’s holdings, and as you’ll see in the next section, analysts see significant upside ahead. 

Is IWM Stock a Buy, According to Analysts?

Turning to Wall Street, IWM earns a Moderate Buy consensus rating based on 1,279 Buys, 637 Holds, and 67 Sell ratings assigned in the past three months. The average IWM stock price target of $230.49 implies 31.75% upside potential.

Reasonable Expense Ratio 

IWM features a reasonable expense ratio of 0.19%. An investor putting $10,000 into the ETF today would pay just $19 in fees over the course of a year. If the fund gains 5% per year going forward and the expense ratio remains 0.19%, this investor would pay $243 in fees over the course of 10 years.  

The Takeaway

IWM looks like an interesting contrarian investment. It has significantly lagged indices like the S&P 500 and Nasdaq in 2023, and it trades at a substantially cheaper valuation. If a recession comes, IWM could lead the way out of it. Additionally, IWM is a diversified and relatively cost-effective ETF, making it a good way for investors to play this theme. 

Disclosure

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



Source link

Latest stories