You own the wrong small-cap fund. How to get into a better one.

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Brett Arends is an award-winning financial writer with many years experience writing about markets, economics and personal finance. He has received an individual award from the Society of American Business Editors and Writers for his financial writing, and was part of the Boston Herald team that won two others.

One of the good things about a market rout is that everything seems to go down together, which means everyone managing their own retirement savings gets a free, or cheap, chance for a portfolio do-over.

The index is fine for many things, such as working out what is going on broadly with small-cap stocks. But it’s less good for us investors. That’s because it includes a vast number of unprofitable and speculative stocks that may, or may not, have any investment value at all. The basic yardstick used to value a stock is the price/earnings ratio, meaning the stock price divided by the net income per share.

The standard approach is simply to ignore all those companies losing money. That estimate of “10 times” trailing earnings, for example: As iShares says, that excludes the numbers for all the companies that are losing money. A spokeswoman for FTSE Russell, which manages the index, said: “We calculate P/E in different ways, and P/E ex Negative earnings is simply one calculated measure among many.” Fair enough. But investors should be aware that 40% of the stocks are unprofitable businesses.

But when our internal markets data team performed the same calculations for this index that they did for the Russell 2000, comparing the total market cap to the aggregate sum of all profits and losses, they found a trailing price to earnings ratio of 23.Is there a single right answer? Maybe not. Let the marketing teams have their day.

 

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Sell the S&P 500. Buy this instead.Brett Arends is an award-winning financial writer with many years experience writing about markets, economics and personal finance. He has received an individual award from the Society of American Business Editors and Writers for his financial writing, and was part of the Boston Herald team that won two others.
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