Most of the stock market's performance in recent years has been driven by large companies -- and it isn't just the megacap tech stocks collectively referred to as the "Magnificent Seven." Meanwhile, small-cap stocks have fallen behind.
In fact, small-cap stocks have collectively underperformed the S&P 500 by 55 percentage points over the past five years, and by 125 percentage points over the past decade. The last time small-caps traded at this much of a valuation discount relative to large caps on a price-to-book value basis was the late 1990s.
However, there's a good reason to believe the gap between small caps and large caps will narrow in the next few years. That's why the Vanguard Russell 2000 ETF (NASDAQ: VTWO) could be worth a closer look right now. Not only could the index fund outperform over the next few years, but it could be an excellent entry point for long-term investors looking to build wealth.
The Russell 2000 is widely considered to be the top index of small-cap stocks. It consists of 2,000 components. The stocks in the Russell 2000 have a median market cap of $3.1 billion, and while it is a weighted index, no single stock makes up more than 0.41% of it.
The Vanguard Russell 2000 ETF tracks this benchmark small-cap index, and it does so for a minimal cost. The fund has an expense ratio of just 0.10%, meaning that for every $1,000 you have in the fund, only $1 will go toward fees. (Note: This isn't something you actually have to pay -- it will be reflected in the performance of your shares.)
Why now could be a great time to buy
I mentioned the valuation gap between small-cap and large-cap stocks, so let's give some numbers to illustrate that. Note that all of these metrics refer to the average of the stocks in the index.
Metric | Russell 2000 | S&P 500 |
|---|---|---|
Price-to-earnings ratio | 16.8 | 26.6 |
Price-to-book | 2.0 | 4.7 |
Data source: Vanguard. All metrics as of 7/31/2024.
So, small-cap stocks as a group are trading for a significantly lower P/E multiple than large caps and for less than half the price-to-book valuation.
However, the Federal Reserve is widely expected to start lowering benchmark interest rates in September, and to continue to lower them for the foreseeable future. A falling-rate environment could be a positive catalyst for small-cap stocks in particular, and for a couple reasons:
Smaller companies are more likely to use leverage compared with large caps, and falling rates mean cheaper borrowing costs.
Smaller companies tend to be the beneficiary of money flowing back into stocks as the yields on risk-free assets decline and investors rotate money into riskier assets that could produce market-beating returns.
What about the long term?
While I believe the Russell 2000 is likely to deliver outsize returns for the next few years, I'm not just suggesting this as a short-term investment. In fact, since its 2010 inception, the Vanguard Russell 2000 ETF has delivered 10.7% annualized returns. If you were to achieve this level of return over a 30-year period, it would turn $10,000 into more than $211,000. If you invest, add to your investment regularly, and hold on for a long period, the Vanguard Russell 2000 ETF could indeed be a millionaire maker.
Should you invest $1,000 in Vanguard Russell 2000 ETF right now?
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Matt Frankel has positions in Vanguard Russell 2000 ETF. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Is Vanguard Russell 2000 ETF a Millionaire Maker? was originally published by The Motley Fool