the larger the company the pricier the stock these days the top 200 stocks on us markets go for 22 times their expected earnings over the next 12 months—42 above their average valuation over the past 35 years according to data from bofa securities’ head of us equity and quantitative strategy savita subramanian mid caps on the other hand trade at a 30 premium to their longterm average valuation and small caps stand at 9 that setup points to superior returns for shares of smaller companies than larger ones going forward longterm investors might consider increasing the weight of small caps in the equity portion of their portfolios the ishares russell 2000 exchangetraded fund ticker iwm is an easy way to gain exposure to the smallcap index valuation isn’t a catalyst goes one wall street maxim but over many years it can still predict longterm performance subramanian calculates that historically pricetoearnings ratios have explained 80 of 10year returns for large caps and 50 for small caps “we see small caps as an area of opportunity for longterm investors where valuations for the russell 2000 suggest midtohigh single digit annualized returns over the next decade and the relative forward pe of large vs small caps 078x vs the historical average of 103x also suggests small should beat large over the next 10 years” subramanian wrote in a report on monday as for large caps pricey stocks suggest a negative return of 1 annually over the next decade that’s the first time subramanian’s longterm valuation model spits out a negative return for the sp 500 since 1999 during the dotcom bubble the bofa quantitative strategist also points to infrastructure spending manufacturing coming back to the us from abroad and an improving esg—environmental social and governance—profile as tailwinds for small caps over the coming years within small caps subramanian likes the more economically sensitive groups consumer discretionary financials industrials and energy she also notes that real estate appears attractive as an inflation beneficiary those sectors all trade at discounts to their largecaps peers and discretionary financials and energy are also cheaper than their longterm median historical valuations on a variety of metrics smallcap technology utilities and healthcare stocks on the other hand look pricey versus their own histories finally subramanian also calls out smallcap value stocks the russell 2000 value index has soared 21 this year—besting the russell 2000 growth’s 5 and the sp 500’s 19 gains—but remains inexpensive versus its historical relative valuations by price to forward or trailing earnings price to book pe to growth and enterprise value to free cash flow that all suggests there’s more room for smallcap value outperformance subramanian wrote the ishares russell 2000 value etf iwn is an option there