Apple’s Domination Brings Small Cap ETFs Into Focus

Contrarian plays surface as iPhone maker’s size matches Russell 2000.

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Reviewed by: Lisa Barr
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Edited by: Ron Day

Last month, Apple stock’s market capitalization climbed to the point where that single company exceeded the size of the entire Russell 2000 Index, the most commonly referenced index of smaller stocks.  

One stock worth more than 2,000 others. 

That May day when Apple and the Russell 2000 were each worth about $2.2 trillion was a watershed. Perhaps it will one day be looked at with the benefit of hindsight as, “that’s when we should have known” that small caps were attractive. 

Perhaps this circumstance shouldn’t come as a total surprise. Small caps, based on the iShares Russell 2000 ETF (IWM), trade only slightly above their price of nearly five years ago, during the summer of 2018. Meanwhile, Apple’s stock price is up fourfold over that time.  

After several years of watching a small number of huge stocks get even bigger while the broader market fails to keep up, financial advisors may be understandably shy about embracing small cap investing for clients.  

However, they may finally have a solid valuation argument. According to data from Ycharts, IWM sells at just about 1x sales, compared to 2.5x for the SPDR S&P 500 ETF Trust (SPY), and a hefty 4.3x for the Invesco QQQ Trust (QQQ). That gap may be enough for investors to start looking at small caps as a contrarian investment. Meanwhile, Apple checks in at a whopping 7.5x sales, and represents 12% of the weighting of QQQ and more than 7% of SPY.  

For advisors and self-directed investors looking to capitalize on the future path of small cap U.S. stocks, following are a few ETFs worthy of consideration.  

The iShares Core S&P Small-Cap ETF (IJR) is based on what many consider to be the second most popular small cap benchmark, the S&P Small Cap 600. This giant $63 billion ETF is actually bigger than its BlackRock counterpart, IWM, by about 30%, and carries an expense ratio of only 0.06% versus 0.19% for IWM.  

While the past performance of the two friendly rivals has been similar over the years, IJR may have a big advantage. Its underlying index screens for companies that meet minimum standards for trading liquidity and financial viability. In other words, just being a small cap company based on market cap is not enough to make it into that index. You can compare IWM and IJR using etf.com’s comparison tool. 

The Pacer U.S. Small Cap Cash Cows Index (CALF), a $2.1 billion ETF, takes that quality theme a step further, starting with the S&P 600, then filtering out stocks expected to produce negative free cash flows or earnings over the next two years. It then takes the results of that filter and chooses 100 stocks based on trailing free cash flow yield. CALF also caps individual stocks weights at 2%, so no one stock can ruin the party. 

And for those who see a small cap comeback as a small percentage chance, the ProShares Short Russell2000 (RWM) is a 16-year old inverse ETF with $453.9 million in assets that uses swap contracts to try to deliver the opposite performance of IWM on a daily basis. 

Small cap stocks used to be the place advisors would go to seek above-average returns in exchange for above-average risk. On a longer-term basis, perhaps years of disappointment in that regard are setting the stage to reverse. If that does occur, advisors may look back at that day in May 2023 when one big-name stock was worth more than the entire bottom row of the classic “style box” and consider that the turning point. 

Rob Isbitts was an investment advisor for 27 years before selling his practice to focus on ETF research and education. He is based in Weston, Florida. Contact him at  [email protected] and follow him on LinkedIn.