Growth Stock Prices Gone Awry?

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Sometimes equity prices and fundamentals diverge dramatically. There is no telling when they will re-converge but history implies that fundamentals ultimately drive stock prices.

Small Growth Stocks Relative to Large Cap Stocks

• Over the past six months, the S&P SmallCap 600 Growth Index has underperformed the large cap S&P 500 index by 6%. However, during that time small cap growth stock fundamentals outperformed—the S&P SmallCap 600 Growth Index earnings per share (EPS) grew 10% faster than S&P 500 EPS.
• This dynamic has driven already inexpensive small cap growth stocks to deep value territory. Indeed, the S&P SmallCap 600 Growth Index price-to-earnings is now at its largest discount to the S&P 500 in more than 20 years.
• Historically, fundamentals drive stock prices so valuation should take care of itself over the long term. The last time the valuation discount between small growth and large cap stocks was this large, in early 2001, the S&P SmallCap 600 Growth Index outperformed the S&P 500 by more than 50% during the subsequent five years.