VIOO - VIOO: Attractive Valuation And Strong Growth Profile But A Recession May Not Be Far

2023-10-09 23:54:07 ET

Summary

• Vanguard S&P Small-Cap 600 ETF has an attractive valuation and strong growth profile.
• VIOO exhibits higher volatility than large-cap funds and may have more downside risks, especially during market turmoil.
• While VIOO has a strong long-term growth outlook, investors should exercise caution due to the potential for a recession coming soon.

ETF Overview

Vanguard S&P Small-Cap 600 ETF ( VIOO ) owns a portfolio of small-cap U.S. stocks. The fund basically tracks the S&P 600 Small-Cap Index. The fund is currently trading at an attractive valuation to its historical level and has a strong growth profile comparable to the S&P 500 index. However, VIOO exhibits higher volatility than its large-cap peer funds and may have more downside risks. Given that a recession may not be too far away, investors may want to exercise caution and wait for the recession scenario to play out.

Fund Analysis

VIOO has been rangebound since mid-2022

Like many other funds, VIOO did not perform well in the first 10 months of last year. In fact, it has fallen about 27% from the peak reached in late 2021 to the trough in October 2022. The fund recovered some of its losses in the first half of 2023 but has soon retreated in the past month as the fear of higher and for longer rate policy caused declines in the stock market broadly. As a result, its fund price is now not far from the trough reached in October 2022.

VIOO can be quite volatile especially during market turmoil

Small-cap stocks usually do not have strong balance sheets than large-cap stocks. Their business models are also not as established as their large-cap peers. Therefore, their stock prices tend to exhibit higher volatility than their large-cap peers. This fact is important to know because in economic downturns, small-cap stocks usually have much higher downside risk than large-cap stocks. As can be seen from the chart below, during the initial outbreak of the pandemic in 2020, VIOO declined by about 42%. In contrast, the S&P 500 index, which consists of large-cap stocks, only declined by about 35%. When the market rebounds, it is also usually large-cap stocks that rebounds first. As the chart below shows, the S&P 500 index recovered much more quickly than VIOO in 2020. The same is also true in the market rally in 2023 as the S&P 500 index rebounded more quickly than VIOO.

Strong growth outlook in the long run

Despite this volatility, VIOO do have a strong growth profile. As can be seen from the chart below, its long-term earnings growth forecast according to the consensus of a group of analysts for each of the next 5 years is 13.6%. This is consistent to its previous long-term earnings growth rate. This growth rate of 13.6% is also comparable to the S&P 500 index’s long-term earnings growth rate of 13.7%.

Attractive valuation

VIOO currently trades at a forward P/E ratio of about 12.3x. As can be seen from the chart below, S&P 600 index’s forward P/E ratio typically trades between 12x and 20x. Therefore, its current valuation of 12.3x is towards the low end of its valuation range. We have not seen this low valuation except during the Great Recession in 2008/2009, the beginning of the pandemic in 2020, and last year’s stock market selloff. Therefore, we think VIOO is trading at an attractive valuation right now. This is especially the case given its strong long-term earnings growth outlook.

Earnings revision may be coming to an end

Besides attractive valuations, there is also one more good news, that is, this negative earnings revision cycle appears to be ending very soon. As can be seen from the chart below, we likely have passed the peak of this negative revision cycle, and stocks in VIOO’s portfolio may soon return to positive earnings growth. This gradual improvement has the potential to allow multiple expansions to VIOO’s forward P/E ratios. Therefore, we may see VIOO’s fund price continue to improve.

Will we enter a recession soon?

VIOO’s valuation appears quite attractive especially with its strong long-term earnings growth outlook. However, a recession may be very near. Our base case is that there will likely be a recession in the first half of 2024 due to the Federal Reserve’s higher for longer rate policy. Although a soft-landing is still possible, an economic recession may result in earnings being revised downward again. This will inevitably impact VIOO’s fund price negatively. Given that stock markets usually do not find its bottom before a recession, but during the recession, we think there is likely downside risks ahead.

Investor Takeaway

VIOO’s valuation appears to be quite attractive especially given its strong growth profile. However, a recession may soon enter the scene in the first half of 2024. Keen investors may want to establish a position first and average down on any price corrections. Conservative investors are advised to exercise caution and patiently wait for the advent of the recession.

Additional Disclosure : This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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