Many investors would agree with the idea that 2010 will at least be a little better than 2009 was. The debate arises when the discussion becomes one of how much better, and which stocks are most apt to lead the way? Large, mid or small caps? (For a review on different type of capitalization mean, read Market Capitalization Defined.)

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Though forecasts are little more than educated guesses, they're still a framework with which we can work. So, let's do just that and assign some values to these groups using Standard & Poor's outlook (and history) for the S&P 500 large cap index, the S&P 400 mid cap index and the S&P 600 small cap index.

Crunching the Numbers
The idea here is simple enough. For all three indices, we will compare the average P/E ratios (operating) over the last three years - counting 2009's numbers so far - to 2010's estimates. An estimate isn't an end-all, be-all, but it's at least a yardstick.

If each index were a company with one share, and could produce operating earnings on it, Standard and Poor's is saying 2010's results should look a lot like 2007's numbers.




Earnings Per Index





2007


2008


2009*


2010**


Averages:


S&P 600


$18.99


$10.22


$8.35


$17.70


$12.52


S&P 400


$42.65


$30.04


$27.46


$41.63


$33.38


S&P 500


$82.54


$49.51


$55.91


$75.27


$62.65


* data through third quarter


** based on estimates


Said another way, here are the corresponding P/E ratios (current index value used to calculate future P/E ratios) for the indices.




Operating P/E Ratios





2007


2008


2009*


2010**


Averages:


S&P 600


20.80


26.28


40.48


19.10


29.19


S&P 400


20.12


17.92


27.10


17.87


21.71


S&P 500


17.79


18.24


26.69


14.81


20.91


* data through third quarter


** based on estimates


Putting it All Together
When put in those terms, what's not to like? Whether you bought heavily into small caps with something like the iShares Small Cap Fund (NYSE:IJR) and the Vanguard Small Cap ETF (NYSE:VB), or decided to stick only with large caps using the iShares Large Cap Fund (NYSE:IVV) or the SPDRs (NYSE:SPY), it looks as if you couldn't go wrong - everything is undervalued, right? Yes, based on the numbers. But are the numbers right - or even plausible?

The large cap projections, though a tad aggressive, are at least within reach. And technically speaking, they are the cheapest (based on operating price to earnings ratios) right now. So, big and boring is also beautiful for 2009.

On the other hand, do we really think small caps can more than double earnings in 2010? Yes, they're nimble, and that counts for something. But this group also took the biggest earnings hits between 2007-2009. So, they're clearly not as nimble as we like to think they are. Unless spending (consumer and business) does the impossible and ramps back up to 2007 levels, The small caps are overestimated - not to mention overpriced - at this point.

And the mid caps? Their earnings held up almost as well as the large caps' did during the recession, and as far as valuations are concerned, those are also on par with their large cap brethren. That alone could be a solid argument in favor of something like the iShares Mid Cap Fund (NYSE:IJH) or the Mid Cap SPDRs (NYSE:MDY) as a 2010 holding. It's not the best one though.

The Bottom Line
No, the best one is that mid caps hold their value consistently better than small or large caps. Over the last one-year, three-year, and five-year time frames, the mid caps are well represented on the leader board. The underlying results from above are the likely reason why. (What sort of market cap should you invest in? To find out, read Determining What Market Cap Suits Your Style.)

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Tickers in this Article: IJR, IVV, SPY, IJH, MDY, VB

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