BofA sees opportunity in small-cap Value over small-cap Growth

Investing.com -- Bank of America analysts said in a note Friday that the broadening of profits growth is “finally extending into small caps,” with the Russell 2000’s 3% return last month “entirely driven by positive EPS revisions.”

The bank explained that the forward price-to-earnings ratio held steady at 16.2x while the implied earnings change was “the most positive since mid-2022.”

The firm noted that small caps saw profits growth inflect positively in 2Q and “both EPS and sales revision ratios have turned positive (hitting multi-year highs).”

BofA added that consensus now expects profit growth for small caps to begin outpacing large caps by 4Q and for this to continue through 2026.

On valuations, BofA noted, “Small caps remain the least-stretched size segment, trading 7% above avg. (since 1985) vs. mid caps 25% above avg. and large caps 44% above avg.”

According to BofA, small caps trade at around a 30% historical discount to large caps, with a relative P/E of 0.72x versus a historical average of 0.99x.

The bank said today’s valuations imply “~8% annualized price returns for the Russell 2000 over the next decade vs. <1%/yr for the Russell 1000.”

BofA emphasized that “the relative P/E for small cap Growth vs. small cap Value continued to expand last month, currently 22% above average.”

The analysts said, “With recovering/broadening EPS growth, Fed cuts and a shift to ‘Recovery’ in the US Regime Indicator – all environments supportive of Value>Growth within small caps – we continue to favor Value.”

Financials remain the top sector in BofA’s small and mid-cap quant work, while Technology also ranks near the top despite screening as expensive.

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