SMID indices now trade at valuations near the high end of historical ranges, thanks to strong performance witnessed in 2013.
Scott T Chronert and Louis L Odette of Citi Research however point out a number of well-positioned SMID stocks, through their Value Creators SMID Focus List.
Growth vs. Valuation face-off
Citi analysts point out that for 2013, it appears that Russell 2000 ex-neg earnings growth will settle in the 6 to 8% range. However, relative to +33% index appreciation year-to-date, the implication is that small cap and broader SMID cap has experienced significant multiple expansion.
The analysts feel such an expansion has led to the SMID indices now trading at valuations near the high end of historical ranges.
On the contrary, trailing earnings growth rates have fallen to levels near historical lows, while forward growth rates have only just ticked higher from their own historical lows.
Thus Citi analysts point out as we head into 2014, the most critical dynamic facing SMID investors relates to this growth vs. valuation face off.
This dichotomy is evident from the following graphs. The following graph highlights trailing PE’s at the high end of their historical range.
The following graph illustrates the trailing and projected 1-year growths are near lows:
Value creators SMID focus list
Through their Value Creators SMID Focus List, Citi analysts have included a number of well-positioned SMID stocks, many of which are also included on the positive revision and quality-growth screens. As can be seen from the following table, the list has generated over 50% on an equal-weighted basis YTD.
Citi maintains 2014 targets for SMID Indices
Citi analysts maintained their initial 2014 targets that were set in September. Thus, their base cases for Russell 200 stands at 1180 (+4.3%), while Russell Mid Cap stands at 1560 (+7.4%) and Russell 2500 stands at 462 (+5.5%).
Citi analysts however caution 2014 may be more about stock specific opportunities than broader index follow through to 2013’s performance.
Style and sectors
Interestingly, Citi analysts point out that despite their emphasis on ‘growth’, their ‘investment style’ calls for the first part of 2014 is in favor of ‘value’. The analysts point out that the SMID value indices are projected to show slower earnings growth than the Growth indices during 2014. But, they are also currently projected to show a more significant rate of change during 2014.
However, the analysts point out that the value style indices continue to trade at lower valuations. For instance, the RUT Value Index is currently trading at 17x 2014 ex-neg EPS estimates, as compared to the RUT Growth Index which trades at 23x.
Turning their focus towards sectors, Citi analysts believe Consumer Discretionary would remain their primary overweight, with a corresponding Health Care underweight. The analysts anticipate stock differentiation to supersede sector influences.