Upward earnings revisions, not higher valuations, have been the main driver of recent gains in US small-cap stocks, Bank of America said, even as micro caps trade at their priciest levels since the tech bubble.
The Russell 2000’s forward price-to-earnings ratio held steady for a third consecutive month at 16.1 times, roughly 6% above its long-term average, according to BofA.
Despite the flat multiple, small-cap returns have stayed positive, supported by stronger profit expectations.
“About three-quarters of the Russell 2000’s 11% return this year has come from upward EPS revisions,” analysts wrote, noting that small-cap earnings “finally emerged from recession last quarter” and are expected to accelerate into 2026.
By contrast, micro caps – the smallest segment of the market – have become notably stretched. “Micro caps are now their most expensive versus the index since the Tech Bubble,” BofA wrote, pointing out that they trade 80% above historical norms on price-to-sales and 22% above on price-to-book measures.
The sector breakdown showed financials as the top-ranked group in both small- and mid-cap quant models, supported by solid valuations and analyst upgrades. Utilities and technology also screened well, while communication services and consumer discretionary sectors ranked among the weakest.
Over the next decade, valuations suggest potential annualized returns of 8% for the Russell 2000, 6% for the Russell MidCap, and 0% for the large-cap Russell 1000, BofA added.