Trader’s Narrative

Last week we focused on how small cap stocks are outperforming the wider market. My suggestion after looking at the short term and long term relationship between the large caps and small caps is that this outperformance should last a bit longer, maybe 2 years more.

That was from a technical analysis point of view, of course. The valuation model from Ford Equity Research provides corroborating evidence from a fundamental analysis point of view. As way of background, here’s how Ford approaches valuation:

Ford’s price to value ratio (PVA) is computed by dividing the price of a company’s stock by the value derived from a proprietary intrinsic value model. A PVA greater than 1.00 indicates that a company is overpriced while a PVA less than 1.00 implies that a stock is trading below the level justified by its earnings, quality rating, dividends, projected growth rate, and prevailing interest rates. While looking at the PVA for an individual company can give a good indication of its value, the average PVA for the market as a whole can provide insight into current valuation levels.

Here is the chart of the S&P 600 index with the comparative PVA valuation below (click chart to open larger version in new tab):

The Smallcap 600 Index advanced 4.2% in February. This price increase combined with unchanged long term interest rates caused the aggregate price to intrinsic value for the Smallcap 600 index to rise. The current level of average PVA for the index remains well below its mean level of 0.87. Based on current earnings, expected growth, and current interest rates, the S&P Smallcap 600 Index is undervalued.

The wider stock market, using the Ford Universe Price Index, hasn’t really budged from the last time we looked at it. You can see a chart here: Another Method Of Stock Market Valuation