Is it a good time to buy small-cap US stocks with a valuation lower than the S&P 500 by nearly 30%?

From the surface, the US stock market has performed strongly this year, with the S&P 500 index rising by about 8%, but these gains have been driven by large technology stocks.

Apple, Amazon, Meta, Alphabet, Microsoft, Nvidia, and Tesla have seen their stock prices rise between 29% and 99% this year.

Smaller companies have struggled, but they now look cheap and it may be time to "take a bite".

Poor performance of small-cap stocks

The market capitalization of large technology stocks is close to $10 trillion, slightly less than one-third of the entire index. However, the S&P 500 index has only risen by single digits, which means that most other stocks have not been so lucky.

The Invesco S&P 500 Equal Weight ETF (RSP), which weights each stock in the S&P 500 index equally, has performed roughly the same as the index this year.

Chris Harvey, chief US stock strategist at Wells Fargo, pointed out that "the market's gains continue to be dominated by super-large-cap stocks, masking the fact that most of the S&P 500 index's components have fallen this year."

The performance of the S&P 600 Small Cap Index is even worse, down about 3% this year.

However, the performance of other small-cap stocks is also mediocre. For example, the industrial sector in the index has only risen by about 4% this year, which is insignificant compared to the returns of technology stocks in the S&P 500 index.

Small-cap stocks look cheap

FactSet data shows that the total forward P/E ratio of the S&P 600 index is slightly less than 13 times, which is nearly 30% lower than the P/E ratio of the S&P 500 index, which is slightly higher than 18 times.

Sometimes, the valuation of small-cap stock indices is slightly higher than that of large-cap stock indices, but even during economic pressures, its valuation has not seen such a large discount. In March 2020, its P/E ratio was only 25% lower than that of the S&P 500 index.

However, due to the risk of performance, the valuation of small-cap stocks is suppressed.

FactSet data shows that analysts have generally lowered earnings expectations for companies in the S&P 600 index over the past year. However, it is worrying that there may be more downgrades considering economic issues.

Now may be the time to buy some small-cap stocks, just don't be too aggressive.