If you were to ask investors what has driven the broader market higher over the past couple of years, you’d likely get a variety of answers, including growth stocks and companies that are monetizing artificial intelligence (AI).
While these themes have certainly contributed to the rally, the more complete answer lies in large-cap stocks.
Even amid last week’s sell-off in growth stocks, many pockets of the market performed well. And you may be surprised to learn that sectors like industrials and energy, led by income and value stocks, are hovering around all-time highs.
Businesses that generate positive cash flow and do not rely on debt have generally been better protected from high interest rates and inflation than smaller businesses. So it makes sense that small-cap stocks have underperformed S&P500 by a wide margin recently. The S&P 500 is up more than 19% during this period, while the Russell 2000 (INDEXRUSSELL: RUT) is down more than 12%.
Here is why the Vanguard Small Cap ETF (NYSEMKT:VB) and its 1,413 holdings are the perfect way to bounce back on small-cap stocks.
Small but powerful
What immediately stands out about the Vanguard Small-Cap ETF is the large number of holdings and the fund’s simple expense ratio of 0.05%, or an annual fee of $5 for every $10,000 invested. Today’s low-cost exchange-traded funds (ETFs) allow investors to diversify and gain exposure to something new at a lower cost.
The median ETF market cap is only $7.3 billion, which is much lower than, let’s say, the median ETF market cap. Vanguard S&P 500 ETF (NYSEMKT: VOL)whose median market capitalization is $224.7 billion.
The Vanguard Small-Cap ETF’s 10 largest holdings make up less than 4% of the fund, so it’s nowhere near as heavy as the S&P 500 or the Nasdaq Compositewhere big tech stocks carry much of the weight.
With this in mind, one of the biggest benefits of the Vanguard Small-Cap ETF is that it provides exposure to many different companies that would be almost impossible to replicate without the help of an ETF.
Sectoral distribution
Some of the ETF’s top holdings include companies you may have heard of, like an AI software company. MicroStrategy, DraftKingsAnd Williams-Sonoma. But most of the fund is focused on value-oriented segments of the market. Interestingly, industrials are by far the ETF’s largest sector. If you look through the fund’s holdings, it’s easy to see why.
Sector | Weight |
|---|---|
Industrial | 22.5% |
Discretionary consumption | 16.4% |
Financial datas | 13.5% |
Technology | 12.9% |
Health care | 10.6% |
Real estate | 6.9% |
Energy | 5.6% |
Basic materials | 4.1% |
Utilities | 3.2% |
Basic consumption | 3.1% |
Telecommunications | 1.2% |
Data source: Vanguard.
A good example of a stock you will find in ETF is Watsco, which distributes, among other products, air conditioning, heating and refrigeration equipment. Another example would be Booz Allen Hamilton, a consulting firm. There is also Casey’s General Storeswhich are mainly concentrated in the American Midwest. Another holding is the house builder Toll Brothers.
These are relatively small companies that are leaders in niches in different sectors. Watsco is a much smaller company than industrial giants like United Parcel Service Or caterpillar. But it plays an important role in its specific market. Casey’s general stores are much smaller than Walmart Or Costco wholesale, so this would not normally appear on the radar of an investor looking to invest in large retail. With this in mind, small caps are simply small compared to the rest of the market, but they are still established multi-billion dollar companies.
There are typically a lot of these types of companies in the industrial sector, which is why the Vanguard Small Cap ETF is a good fit for investors who like the value and income the sector has to offer, while still gaining exposure to the character cyclic. and the potential gain to the economy as a whole.
Ready for a turnaround
One of the simplest reasons why small-cap stocks are now good buys is that many of them are cheap. The average price-to-earnings (P/E) ratio for a holding in the Vanguard Small Cap ETF is just 18.2, and the average price-to-earnings (P/E) ratio is 2.4. For comparison, the average P/E ratio for a holding in the Vanguard S&P 500 ETF is 26.1 and the average P/B is 4.5.
Small-cap stocks arguably deserve to trade at a lower price than the S&P 500 because they don’t have the advantages of large companies. Still, a 30% difference between the P/E ratio of the Vanguard Small Cap ETF and the Vanguard S&P 500 ETF is considerable.
If the market continues to sell off, investors could turn to quality companies offering better values, such as small caps, which have been largely excluded from the broader market rally.
A role in a diversified portfolio
One reason an ETF might be better suited than an individual stock is that it can serve a specific purpose in a portfolio. For example, an investor seeking greater exposure to AI may choose an AI-focused ETF. Or, an investor looking for large, safe, dividend-paying value stocks may opt for Vanguard Value ETF.
The Vanguard Small Cap ETF is perfect if you’re looking for hidden gem companies but don’t know where to start. Or if you’re looking for depressed value stocks. Regardless, the Vanguard Small Cap ETF makes opening starting positions in 1,413 small-cap stocks easy and inexpensive.
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale, Vanguard Index Funds-Vanguard Small-Cap ETF, Vanguard Index Funds-Vanguard Value ETF, Vanguard S&P 500 ETF, Walmart, Watsco, and Williams-Sonoma. The Motley Fool recommends Booz Allen Hamilton, Casey’s General Stores and United Parcel Service. The Mad Motley has a disclosure policy.
This Top Vanguard ETF and its 1,413 holdings are poised for a rebound. Here’s why. was originally published by The Motley Fool
