Hulbert: Small Cap Sector Shockingly Overvalued

In a recent MarketWatch article, Mark Hulbert reveals a revised calculation that the small-cap sector is currently valued at a whopping 78.7 times earnings. He writes, “the Russell 2000’s true P/E today is higher than it was at either the top of the internet bubble or the 2007 bull market peak.”

Hulbert describes the calculation, which he credits to financial services firm INTL FCStone’s Vincent Deluard, who told him that nearly a third of the companies in the Russell 2000 index are losing money. This omission, writes Hulbert, “has huge consequences.” Neither the FTSE Russell (the company that created the Russell index) nor iShares (which manages a well-known ETF benchmarked to the Russell) conceals the fact that they “ignore companies with negative earnings.” Deluard likens the practice to “the creative accounting practices used during the internet bubble,” and points out that the true P/E is determined by dividing the combined total market cap of all companies included in the index by their total trailing 12-month earnings.

When Deluard did that calculation, writes Hulbert, “he discovered that the Russell 2000’s true P/E is 78.7.” He concludes, “Needless to say, you may have other reasons for believing the small-cap sector to be undervalued right now. But don’t try to justify your bullishness by claiming that the Russell 2000’s P/E is in the range of 19 to 26.”