Why High Small-Cap P/Es Might Not Be So Bad

Small-cap valuations are quite high these days, but newsletter guru Jim Oberweis says there may be good reason for that: institutional investors being “desperate” to reach pension fund goals.

“Traditionally, pension plans allocate 40% to fixed income, implying that an 11% return is required on the rest of the portfolio to hit their targets,” Oberweis says in his latest Forbes column. “Unfortunately, the market averages only 8% annually. Other than raising taxes to increase contributions, the most realistic scenario is for the funds to bet it all on black — increasing allocations to higher-returning asset classes, such as small caps and international equities.” That, he says, could mean higher valuations for growth plays. “It’s plausible investors will pay top dollar for stocks with megagrowth potential until inflation returns to bail out unrealistic actuarial estimates.”

Oberweis says a structural shift that makes small-cap P/Es higher wouldn’t be unprecedented — it happened back in the 1970s as well, he says. He looks at three high-P/E, high-growth small-caps he likes, including medical device company Cardiovascular Systems.