The p/e ratio on estimated 2010 eps for the Value Line equal
weighted arithmetic index (1700+ stocks) is now over 20x as it
is for the Russell 2000 smaller cap index. This compares to a
15.1 p/e for the SP 500 on a comparable estimate. The p/e
premium for the mid / small cap indices has been expanding
as this cyclical bull market rolls along. Moreover, the smaller
the cap, the faster has been the acceleration of relative p/e.
My view on this issue is that too many stocks are now trading
at riskier high p/e's and that if you like the smaller caps as I do,
you have to become far more selective going forward. The big
problem with smaller cap, faster growing companies is that folks
rarely are realistic in looking at how quickly and rapidly growth
potential can decay over time. they tend to extrapolate high
growth rates out too far in time to justify the p/e ratio so that
the earn-out period remains competitive with other stocks. Thus,
when the smaller guys go to a premium, it is likely that the
universe of overpriced srocks is expanding. So, you have to
research the potential of smaller cap stocks more carefully now
and not rely on the positive price momentum of the market
to bail you out.
The best method I know to tell when capitalization size preference
may be changing is to look at the relative strength of the mid /
smaller universe compared to the cap weighted SP 500. Have
a look at the Value line Arithmetic ($VLE) compared to the
SP 500 which I link to below. Notice the importance of RSI in
the short run and the power of trend favoring the $VLE since
late 2008. It will take a substantial break of trend to confirm a
change of leadership. Chart.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!