Tired of Pricey U.S. Stocks? This Cheap Alternative Is at a 50-Year Low

As the U.S. stock market rallies to new highs, relative valuation metrics are sending a clear warning: the market may be overheated, but they are also revealing potential opportunities. Mark Cooper, Chief Investment Officer at MAC Alpha Capital Management, suggests investors should be wary of stocks with high price-to-sales ratios and points to international small-cap value stocks in developed markets outside the U.S. as likely to significantly outperform the S&P 500 over the next decade.

Valuation Warning: Price-to-Sales Ratios Reveal Overvaluation Risks

While investors often focus on forward price-to-earnings ratios for large caps, the price-to-sales ratio is a more reliable metric for evaluating small-cap stocks. According to FactSet, the S&P 500’s trailing price-to-sales ratio stands at 3.21, nearing its August 2021 record of 3.26. This is 67% above its 20-year average of 1.92 and 35% higher than its 10-year average of 2.42.

The S&P 500 is highly concentrated in a few mega-caps. The SPDR S&P 500 ETF Trust has 20.9% of its weight in its top three holdings—Nvidia, Microsoft, and Apple—and 27.8% in the top five, which also include Amazon and Meta. These giants are trading at significant premiums to their 10-year average price-to-sales valuations:

• Nvidia: 23.43 (38% premium)
• Microsoft: 12.94 (41% premium)
• Apple: 8.56 (58% premium)
• Amazon: 3.62 (12% premium)
• Meta: 10.08 (6% premium)

Cooper highlighted speculative froth in the market, noting that about 300 U.S. stocks trade at price-to-sales ratios of 10 or higher—close to the 400 seen in March 2000, before the dot-com bubble burst—while the total number of listed companies is now only half what it was then. The most expensive stock in the S&P 500 by this measure is Palantir Technologies, with a ratio of 98.5, followed by Strategy Inc. (formerly MicroStrategy) at 219.1.

The Opportunity: Three Cases for International Small-Cap Value Stocks

Cooper makes three arguments for investing in non-U.S. developed market small-cap value stocks:

1. Relative Valuation Advantage: Stocks in developed non-U.S. markets, represented by the MSCI EAFE Index, are priced far lower than the S&P 500. Based on 55 years of data, the MSCI EAFE would need to outperform the S&P 500 by a cumulative 27% over five years just to revert to its long-term average relative valuation.
2. Value Stocks Are Cheap: Global value stocks are trading at historically low levels relative to growth stocks.
3. Underweight Positioning: U.S. investors currently allocate only 4% to small-cap stocks, well below the historical average of 7.5. A reversion to the mean could drive significant outperformance.

Cooper emphasized that this asset class is at its cheapest level relative to the U.S. market in at least 50 years, offering compelling long-term value.

How to Invest: Three ETFs for Low-Cost Exposure

For investors seeking broad exposure to international small-cap value stocks, FactSet lists three ETFs as direct competitors:

• Avantis International Small Cap Value ETF (AVDV): $11.6 billion in assets, actively managed, holds 1,436 stocks, expense ratio 0.36%, Morningstar Rating: 4 stars.
• Dimensional International Small Cap Value ETF (DISV): $3.4 billion in assets, actively managed, holds 1,478 stocks, expense ratio 0.42%, top performer over the past three years, Morningstar Rating: 4 stars.
• iShares International Developed Small Cap Value Factor ETF (ISVL): $48 million in assets, tracks an index, holds 502 stocks, expense ratio 0.30%, Morningstar Rating: 3 stars.

All three ETFs have outperformed the MSCI EAFE Small Cap Value Index, the broader MSCI EAFE Small Cap Index, and the SPDR S&P 500 ETF Trust over the past three years through Wednesday.

Funds Personal Finance Value Stocks