At the beginning of 2024, small-cap stocks were trading for their lowest price-to-book valuation relative to large caps since the late 1990s. And thanks to slower interest rate cuts than many expected, combined with the surge in mega-cap technology stocks, the gap became even wider throughout the year. As we head into 2025, the average small-cap stock trades for 2 times book value, compared with a median price-to-book multiple of 5 for the large-cap S&P 500 index.
To be sure, there are some reasons the S&P 500 should be a little more expensive. The concentration in big tech companies is a big one. But there’s good reason to believe that the gap has become far too wide and a number of catalysts could cause it to narrow in 2025 and for the next several years.
For that reason, the Vanguard S&P Small-Cap 600 ETF (VIOO 1.59%) could be an exceptional investment opportunity right now, from a long-term perspective. Here’s a brief overview of the index, the ETF, and some reasons to be optimistic about it as we head into the new year.
The Vanguard Small-Cap 600 ETF
Although the S&P 500 gets most of the attention, there are actually three main S&P indices that group stocks based on size. The S&P 500 is the largest companies in the U.S., the S&P Mid-Cap 400 focuses on midsize companies, and the S&P Small-Cap 600 focuses on smaller businesses. Collectively, the three indices make up the S&P 1500, which is a total stock market index.
As the name suggests, there are 600 companies in the S&P Small-Cap 600. The median market cap of the index components is $3.4 billion, about 1.3% of the size of the median S&P 500 company.
While the Small-Cap 600 is a weighted index, no stock makes up more than 0.66% of the total weight, a sharp contrast to the S&P 500, where the 10 largest stocks make up 35% of the index’s performance. Just to name a few, some of the top holdings you might be familiar with include Bath & Body Works (BBWI 0.38%), Etsy (ETSY -0.26%), Shake Shack (SHAK -1.58%), and Madison Square Garden (MSGS 0.93%).
The Vanguard Small-Cap 600 aims to track the index’s performance, net of fees, over time. And speaking of fees, the index fund’s expense ratio is just 0.1%, which means that you will pay just $1 in annual investment fees for every $1,000 invested. (Note: This isn’t a fee you have to actually pay. It will be reflected in the performance over time.)
Why now?
In addition to the valuation gap mentioned earlier, there are some good reasons to take a closer look at the Vanguard S&P Small-Cap 600 ETF.
For one thing, small-cap stocks tend to be a little more debt-reliant on average than their large-cap counterparts, so they could benefit from falling interest rates over the next few years. Plus, by definition, small-cap stocks as a group have higher growth potential and can thrive in strong economies. There’s also the matter of the incoming Trump administration, which has generally pro-business policy stances and could provide a nice tailwind.
Having said all of that, I’m not suggesting a closer look at the Vanguard S&P Small-Cap 600 ETF just because of what it can do in 2025. This is an excellent long-term investment vehicle. Since the fund was formed about 15 years ago, it has delivered a 12% annualized total return for investors. While that doesn’t necessarily mean you’ll get the same results in the future, the point is that this is a high-potential index fund with a valuation gap that makes it look like a great time for long-term investors to buy.
Matt Frankel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Etsy. The Motley Fool has a disclosure policy.
