Question 1: Is it time to invest in small-cap growth stock?

Examaination of valuation of top-10 small-cap and large-cap growth stocks indicates both sectors are overvalued at the start of 2024.

True/False:   Small cap growth stocks are obviously a much better value than large-cap growth stocks?

Hint: You are pretty safe saying false whenever the word obviously is used in a true-false question.

FALSE:  Many analysts pointing to the stellar 2023 year for large-cap growth stocks are saying 2024 is the year for small-cap growth stocks like VBK the small-cap growth fund offered by Vanguard.  My analysis of the data indicates that both VBK, the small-cap growth fund and VOOG, a large-cap growth stock fund, are overvalued at the start of 2024.

Analysis:

Both funds did well in 2023 due to a strong end-of-year winning streak.  The gain for 2023 was 23.15 percent for VBK and 30.43 percent for VOOG. 

An analysis of PE ratios for the top-10 holdings in the two funds suggests that small-cap firm valuations may be higher than large-cap firm valuations.

Small-cap firm valuations:

  • Six of the top-ten small-cap firm holdings had a PE ratio over 50, including one firm with a negative PE ratio.
  • Three of the firms had a PE ratio between 25 and 30.
  • None of the firms had a PE ratio less than 20.
  • The correctly calculated PE ratio for the ten small-cap growth stocks is 70.97.  (See methodological note below.)
  • The top 10 holdings in the small-cap growth portfolio represent less than 8.0 percent of holdings in VBK.

Large-cap firm valuations:

  • Four of the ten large-cap growth valuations had a PE ratio over 50.
  • Only one of the 10 firms, Exxon (PE=9.93) had a low PE.  All other firm PE ratios were over 20.  (I am not sure why XOM is included in a growth portfolio, all though it does provide balance)
  • No firm had a negative PE ratio.
  • The correctly valued PE ratio for the 10-stock large-cap portfolio is 30.94.  (See methodological note below.)
  • The top 10 holdings in the large-cap growth portfolio represent over half of the portfolio.

Concluding thought:  A quick snapshot of the top ten holdings of VBK (a small-cap growth portfolio) and VOOG (a large-cap growth portfolio) found that top holdings of VBK have higher valuation than top holdings of VOOG.  The top holdings of VOOG clearly skyrocketed in 2023 and many investors are now seeking diversification, but VBK is NOT A BARGAIN and is in fact probably riskier than VOOG.

Methodological Note:  A portfolio PE cannot be estimated from the average of stock PE ratios because firms with negative earnings do not have a defined PE ratio and firms with earnings near zero have PE ratios that are outliers that dominate the average of the PE ratios.  One way to calculate the official PE ratio for a portfolio described in this post and in this longer paper involves a transformation of the statistic f=(p-eps)/eps.

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