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Small-Cap Stocks: A Potential Opportunity

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Small-cap stocks have reached their lowest level in 14 months, presenting a compelling buying opportunity, according to research from BofA Global. While immediate price rebounds are not guaranteed, analysts suggest that the small-cap segment may offer better returns in the long run.

In comparison to their large-cap counterparts, small-cap stocks have significantly underperformed this year. The Russell 2000, which represents the 2,000 smallest companies in the Russell 3,000, has experienced a 3.1% decline year-to-date. Meanwhile, the S&P 500 has seen a 15% increase, and the tech-heavy Nasdaq Composite has soared with a 32% return (FactSet data).

Following recent market sell-offs, the price-to-earnings ratio of the Russell 2000 has dropped to 12.3, reaching a 14-month low (BofA Global). With small-cap stocks currently trading at a 19% discount to historical averages in terms of market capitalization, they present a more affordable option compared to midcap and large-cap stocks, now trading at a 4% and 12% premium, respectively. Megacap stocks, represented by the Russell Top 200, also show a significant premium of 18%.

However, it is important to note that while small-cap stocks are priced attractively, this does not automatically indicate an imminent price increase. Valuation is not a reliable short-term timing indicator but rather holds explanatory power in the long term, as explained by analysts.

Looking ahead to the next decade, BofA Global’s research indicates that the Russell 2000’s price-to-earnings ratio suggests a potential annualized return of 12%, compared to 7% for the Russell 1000.

Read: Tempted to go bargain-hunting for small-cap stocks? Why you might want to wait.

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