Investing in Small-Cap Stocks: A Vanguard ETF to Consider for 2025

Analysts from Jefferies have provided their predictions for the S&P 500 index, setting a target of 6,000 for the year 2025. This target suggests a potential decline of about 1% from its current level of 6,050, positioning it among the more bearish forecasts on Wall Street. However, the analysts see bright prospects in the small-cap segment of the stock market.

According to Jefferies, small-cap stocks could stand to gain significantly, with the Russell 2000 index expected to reach 2,715 by the end of 2025. This projection indicates a promising upside of about 16% from its current benchmark of 2,345. Furthermore, Tom Lee from Fundstrat Global Advisors anticipates that small-cap stocks will generate returns at least double those of the S&P 500 in the coming years.

For investors eager to partake in this potential growth, the Vanguard Russell 2000 ETF (VTWO) offers a straightforward way to gain exposure to small-cap stocks. Let’s explore this option further.

Understanding the Vanguard Russell 2000 ETF

The Russell 2000 index tracks the performance of approximately 2,000 small-cap companies, which make up about 5% of the total market value of U.S. equities. These companies have a median market capitalization of $1 billion, meaning that half the companies hold higher valuations, while the other half fall below this threshold. Notably, no company within the Russell 2000 is valued above $18 billion.

The Vanguard Russell 2000 ETF mirrors the performance of the Russell 2000 index. It encompasses a diverse range of stocks from various sectors, including both value and growth stocks. The ETF has significant weightings in three primary sectors: industrials (20%), financials (18%), and healthcare (16%).

The ETF’s largest holdings by weight are as follows:

1. FTAI Aviation: 0.5%
2. Sprouts Farmers Market: 0.5%
3. Vaxcyte: 0.5%
4. Insmed: 0.4%
5. Mueller Industries: 0.3%

Why Small-Cap Stocks May Outperform

There are a few critical factors that suggest small-cap stocks may surpass the performance of large-cap stocks in 2025:

1. **Interest Rate Cuts**: Small-cap companies often have more floating-rate debt, and as interest rates decline, their interest payments decrease, leading to larger profit margins.

2. **Valuation Premiums**: The Russell 2000 trades at a 26% premium relative to its average price-to-earnings (P/E) ratio from the last two decades, while the S&P 500 carries a 41% premium. This makes small-cap stocks more attractive in terms of valuation.

3. **Earnings Growth**: Forecasts indicate that small-cap companies within the Russell 2000 are expected to report earnings growth of 41% in 2025, compared to a more modest 15% growth for S&P 500 companies. This potential for higher growth, paired with more appealing valuations, could aid small-cap stocks in outperforming their larger counterparts.

Challenges Facing Small-Cap Stocks

While there are many reasons to be optimistic about small-cap stocks, they have historically underperformed compared to larger companies. Fewer than 10% of S&P 500 firms show unprofitability, whereas over 40% of Russell 2000 companies are unprofitable, illustrating the financial challenges they face.

This performance discrepancy becomes clear when examining returns over various time frames:

Time Period	Russell 2000 Return	S&P 500 Return
1 Year	19%	30%
3 Years	14%	37%
5 Years	53%	107%
10 Years	134%	262%

Considering the above data, while there is potential for small-cap stocks to outperform large-cap stocks, the resilient financial standing of the S&P 500 and its historic outperformance raise caution.

In conclusion, though small-cap stocks may hold the promise of outperformance in the near future, it's crucial to weigh these opportunities against their historical challenges. The Vanguard Russell 2000 ETF presents a solid option for investors wishing to tap into this segment, but individual investment strategies should be made with caution.

small-cap, stocks, ETF