Right now, the price-to-earnings ratio of the 500 largest listed companies in the United States – aka the S&P 500 – is between 25–26x.
Meanwhile, the price-to-earnings ratio of the Morningstar US Small Cap Index is under 15x.
This is a huge valuation gap.
And to be sure, some of it is not unwarranted. Large-cap growth stocks have a good reason to be expensive – especially considering they’re the ones with the balance sheet and market power to best survive a high-interest rate and potentially recessionary environment.
But this valuation gap is, historically speaking, the largest valuation gap since early 2000. In fact, for a 15-year period between 2004 and 2019, small-cap stocks actually traded at higher valuations compared to large-cap stocks.
This means there’s a big opportunity in small-cap stocks as the market corrects.
And today’s stock pick may be one of the best – and most diversified – ways to exploit this historic valuation gap. Oh, and did I mention you’ll get an 8% dividend yield too?
Royce Value Trust Inc. (RVT)
Royce Value Trust is a closed-ended fund that focuses on investing in US small-cap stocks. As a refresher, closed-ended funds do not issue new shares after the initial issuance, meaning any shares you pick up will be through the secondary market (aka from existing shareholders).
RVT’s performance benchmark is the Russell 2000 – and they’ve beat it for over 35 years.
One thing I want to highlight is RVT’s performance from 2000–2003, where it delivered a 36.3% total return – while the S&P 500 declined by 37.5%.
Of course, we know what happened right before 2000. Valuations of large-cap stocks soared – with price-to-earnings ratios reaching the mid-20s – while small-cap stocks stayed in the mid-teens.
That’s too similar to what’s happening today to ignore. If you’re looking for a diversified way to exploit the valuation gap that’s sure to narrow in the coming months – consider RVT. Plus, as I said earlier, you’ll also pick up a nice 8% dividend yield.
To your wealth,
Felix @ Ace of Investing
