The "Global Gorillas" May Finally Be Having Their Day

By on January 24, 2011

Last week large cap stocks performance was dominant relative to small and mid-cap stocks. Ben Levisohn, writing for the Wall Street Journal, explores the virtues of this much unloved group of stocks, which have suffered over the past decade.

there are signs that large caps’ days in the doghouse may be coming to an end. “They’re cheap, unloved and no one wants to own them, but the points are aligning for large caps,” says David Rolfe, chief investment officer of Wedgewood Partners in St. Louis.

Levisohn points out the valuation disparity:

Small-company valuations, meanwhile, seem stretched. The price/earnings ratio of small-cap stocks is currently about 17, compared with about 14 for large caps. That puts the ratio of the valuations of small to large at about 1.2, equal to the highest ever recorded, according to Credit Suisse Group.

What’s more, a valuation measure known “expected returns,” which forecasts a company’s share-price performance based on its expected cash flow, also points to small-caps being overvalued, says Mark A. Keleher, chief executive of BNY Mellon Beta Management. His research suggests that gains from the Russell 2000-stock index of small caps will come in 0.2 percentage point below large caps during the next decade, the worst differential since BNY began using this method in 1976.

Both valuation metrics were near these levels in June 1983; over the next decade the S&P 500 handily outperformed the Russell 2000, returning 10.4% annually vs. 6.5%.

“We’ve never seen these valuations before,” Mr. Keleher says. “Large caps will definitely have their day.”

Source: Wall Street Journal

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