Volatility Equities Chart

Are Small-Cap Stocks Further Along the Road to Recovery?

13 December 2022

3 min read

Samantha S. Lau, CFA| Chief Investment Officer—Small and SMID Cap Growth Equities

James MacGregor, CFA| Chief Investment Officer—US Small and Mid Cap Value Equities; Head—US Value Equities

Historically low valuations and sharper downward earnings revisions relative to large-cap stocks suggest a quicker ramp-up for small-caps.

Left: 2023 forward EPS estimates are through year to date; 2024 estimates begin February 28, 2022, and are through year to date.
As of November 30, 2022 (left) and October 31, 2022 (right)
Source: Bloomberg, FactSet and AllianceBernstein (AB)

Small-cap companies are usually the most vulnerable to volatility, with their stock prices and earnings getting hit particularly hard and early in economic downturns, much like what occurred in 2022. Yet they also tend to lead the way on both fronts during recoveries.

In fact, after significantly underperforming their large-cap peers over the last few years, small-cap valuations have become more compelling. And recent earnings forecasts are adding to their recovery potential.

Earnings forecasts reveal an interesting discrepancy between larger and smaller stocks. Consensus 2023 earnings-per-share (EPS) estimates for US small-caps dropped 15.9% from January 1 through November 30, 2022, versus just 5.4% for large-cap estimates (Display).

Further out, preliminary earnings forecast revisions for 2024 have trended much more positive for small-caps (0.3%), while still trending sharply downward for large companies (–7.5%). We think the greater drop in near-term earnings estimates suggests that expectations may already be factoring in more challenges from a potential recession. While estimates further out are harder to have confidence in, they suggest that small-caps can offer greater upside as the economy gradually recovers.

Valuation Gap Looks Extreme

Meanwhile, small-cap stocks are also trading at extremely depressed valuations—the lowest in 20 years—compared to larger companies, based on price-to-earnings ratios. Current geopolitical tensions and macroeconomic uncertainties have disproportionately and indiscriminately impacted small companies. Investors have discounted further potential hazards for small-caps, without regard to company fundamentals. So, we think firms that offer resilient business models will stand out and benefit the most along the road to recovery.

Small-cap stocks are commonly seen as riskier than other asset classes. But their relatively higher volatility can create opportunity, too. We believe that companies that combine attractive valuations and high-quality features such as strong management teams, good business models and solid balance sheets can best navigate the uncertain future.

So, even if there’s more macro pain and market volatility ahead, smaller stocks might be further along the route to recovery. We think small-cap valuations and forward estimates reflect investors having discounted many of the hazards ahead—perhaps more so than for large-caps. Investors who have been underweight small-caps in their allocations might want to consider re-positioning toward portfolios of small or mid-size companies that offer resilient business models currently trading well below their long-term potential.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Authors

Samantha S. Lau, CFA

Samantha S. Lau was named Chief Investment Officer of Small and SMID Cap Growth Equities in October 2023. Previously, she was the co-chief investment officer of Small and SMID Cap Growth Equities since 2014. Lau joined the firm in 1999 as a portfolio manager/analyst responsible for research and portfolio management for the technology sector of AB’s Small and SMID Cap Growth strategies. From 1997 to 1999, Lau covered small-cap technology companies for INVESCO (NY) (formerly Chancellor Capital Management). Before joining Chancellor in 1997, she worked for three years as a healthcare securities analyst in the investment research department of Goldman Sachs. Lau co-chaired the Women’s Leadership Council at AB from 2019 to 2022. She holds a BS (magna cum laude) in finance and accounting from the Wharton School at the University of Pennsylvania and is a CFA charterholder. Location: New York

James MacGregor, CFA

James MacGregor was appointed Chief Investment Officer of US Small and Mid Cap Value Equities in 2009. In this role, he acts as the lead portfolio manager for AB’s US Small and Mid Cap Value strategies. MacGregor was appointed Head of US Value Equities in 2019, responsible for all US Value portfolios in the areas of business management and talent development. From 2009 to 2012, he also served as CIO of Canadian Value Equities. From 2004 to 2009, MacGregor was director of research for Small and Mid Cap Value Equities, overseeing coverage of companies for the Small Cap and Small/Mid Cap Value services. He started as a research analyst covering a wide number of sectors for those same services. Prior to joining the firm in 1998, MacGregor was a sell-side research analyst at Morgan Stanley, where he covered US packaging and Canadian paper stocks. He also serves as a board member and volunteer for Xavier Mission, a charitable organization that provides basic services and opportunities for empowerment and self-sufficiency to New Yorkers in need. MacGregor holds a BA in economics from McGill University, an MSc in economics from the London School of Economics and an MBA from the University of Chicago. He is a CFA charterholder. Location: New York

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