BofA: ‘Ongoing Multiple Expansion Continues to Drive Returns’

Investing.com reports that Bank of America has highlighted that multiple expansion is a significant factor driving returns in small and mid-cap stocks, although the outlook for earnings recovery remains unclear.

In a recent analysis, the bank noted that in September, the price-to-earnings (P/E) ratios for small, mid, and large-cap stocks saw an increase. The forward P/E for the Russell 2000 rose to 15.8, slightly higher than its historical average of 15.2. Likewise, the Russell MidCap’s P/E increased to 17.8, while the Russell 1000 reached 21.5, both above their long-term averages.

Despite small-cap stocks trading above average across all metrics monitored, including P/E, price-to-book, and EV/FCF ratios, analysts express caution regarding short-term fundamentals. The report indicates that the Russell 2000 is still exhibiting weak earnings growth, and BofA’s U.S. Regime Indicator has moved further into a “Downturn” phase, a period during which small caps have typically underperformed relative to large-cap stocks.

Looking at the long-term perspective, the relative P/E ratio of the Russell 2000 compared to the Russell 1000 has decreased to 0.73, which is approximately 30% below its historical average.

Bank of America suggests that small caps may provide attractive long-term returns, with estimated annualized growth of 9% over the next decade, in contrast to just 1% for large caps. However, in the short term, the bank favors mid-cap stocks over small caps, citing better trends in earnings revisions and more favorable guidance.

“Near-term, we favor mid over small: mid caps have better revision/guidance trends, have historically outperformed small during ‘Downturn’ regimes, and have more frequently led small following the start of Fed cuts,” the report concluded.